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Author: 


Bennett,  George  Edward 


Title: 


Advanced  accounting 


Place: 


New  York 

Date: 

1922 


COLUMBIA  UNIVERSITY  LIBRARIES 
PRESERVATION  DIVISION 

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Advanced  accounting,  by  George  E.  Bennett ...    1st  ed. 
New  York  [etc.]  McGraw-Hill  book  company,  inc.,  1922. 

xiv,  661  p.    23^"'.      C$4,003 


1.  Accounting. 

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ADVANCED  ACCOUNTING 


ADVANCED  ACCOUNTING 


BY 


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TlkQrmOliR Book  QxTm 

PUBLISHERS    OP    BOOKS     POIV^ 

Ilectrical  Wjrid  v  Engineering  News -Record 
Pover  V  Engineering  and  Mining  Joumal-Rress 
Chemical  and  Metallurgical  Er^ineerir^ 
Hectric  Railway  Journal  v  Coal  Age 
American  Machinist  "^  Ii^genieria  Intemacicttial 
Electrical  Merchandising  v  BusTransponation 
Journal  of  Electricity  and  Western  Industry 
Industrial  Ei^ineer 


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GEORGE  E.  BENNETT.  A.  B.,  LL.  M., 

CERTIFIED  PUBLIC  ACCOUNTANT;  PROFESSOR  OF   ACCOUiItiNG 
COLLEGE   OF  BUSINESS  ADMINISTRATION  ' 

SYRACUSE   UNIVERSITY 


First  Edition 


McGraw-Hill  book  company,  inc 
new  york:  370  seventh  avenue 

LONDON:  6  A  8  BOUVERIE  ST.,  E.  C.  4 

1922 


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Copyright,  1922,  by  thJI 
McGraw-Hilx.  Book  Company,  Inc. 


PREFACE 

In  issuing  this  volume,  the  author  hopes  that  the  material 
will  be  found  useful  in  connection  with  the  problems  which  arise 
continually  in  the  more  advanced  phases  of  accounting  as  prac- 
ticed to-day,  rather  than  be  considered  a  production  devoted  to 
developing  an  individual's  pet  theories.  This  book  is  presented 
primarily  as  a  text,  and  is  based  on  the  present  course  in  ad- 
vanced or  second  year  accounting  as  given  in  the  College  of 
Business  Administration  at  Syracuse  University.  It  represents 
a  conscientious  attempt  on  the  part  of  the  author  to  present 
material  for.  the  advanced  accounting  student  in  such  a  man- 
ner that  he  may  secure  a  working  knowledge  of  accounting 
practice  as  well  as  a  certain  ability  to  discuss  various  theories 
of  accounting  science. 

An  endeavor  has  been  made  to  present  principles  illustrated 
by  a  large  number  of  examples,  and  problems "  together  with 
solutions,  in  accord  with  a  basic  plan  which  is  the  result  of 
nearly  three  years  of  experimentation  and  study.  The  material 
has  been  worked  over  in  the  class-room  with  both  day  and 
evening  students,  both  by  the  writer  and  his  associates  until  it 
has  seemed  to  be  the  most  serviceable  form  for  impressing  prin- 
ciples upon  the  students.  In  view  of  the  strenuous  effort  which 
has  been  made  to  avoid  technicalities  and  to  make  the  exposi- 
tion clear  and  simple,  the  author  also  ventures  to  hope  that  this 
book  will  be  useful  not  only  to  college  students  but  to  all  who 
are  vitally  interested  in  accounting. 

The  first  three  chapters  attempt  to  bridge  the  gap  between 
elementary  and  so-called  advanced  accounting,  which  many 
teachers  recognize  as  existing  in  most  presentations  of  the  sub- 
ject. It  was  deemed  advisable  to  present  a  thorough  review  of 
elementary  principles  necessary  in  the  study  of  advanced  work 
since  they  have  often  been  forgotten  or  are  at  least  vaguely 


tl  PREFACE 

remembered  by  the  average  student.  Following  these  chapters, 
principles  of  corporate  accounting  are  presented  with  consider- 
able  stress  on  the  legal  whys  and  wherefores  underlying  them. 
Later,  the  effort  has  been  to  present  material  relative  to  financial 
statements,  concerning  which  little  is  available  in  other  publica- 
tions, although  this  is  an  essential  part  of  the  accountant's 
knowledge.  The  material  relating  to  fiduciary  work  is  included 
for  the  same  reason. 

The  author  desires  to  express  his  indebtedness  to  two  of  his 
associates,  Thomas  J.  McCormick  and  Philip  E.  Bunker,  for 
the  great  care  with  which  they  have  constructively  criticized 
and  assisted  in  the  revision  of  the  original  manuscript.  More- 
over, the  author  realizes  that  whatever  value  the  views  ex- 
pressed may  have,  has  been  derived  from  a  large  number  of 
professional  contacts.  And  the  opinions  expressed  are  often 
those  of  many  whom  the  author  considers  as  the  highest  au- 
thorities among  present-day  practitioners. 

It  is  suggested  that  teachers  using  this  book  for  classroom 
instruction  may  find  it  profitable  to  follow  the  methods  used  in 
the  classes  at  Syracuse  University.  After  covering  the  material 
in  the  earlier  chapters  by  means  of  considerable  discussion,  it  is 
the  author's  custom  to  assign  readings  in  the  succeeding  chapters 
to  be  carried  on  concurrently  with  the  answering  and  solution  of 
assigned  questions  and  problems  which  will  be  found  in  the  ap- 
pendix. In  other  words,  after  a  satisfactory  start  has  been  made, 
theoretical  classroom  lectures  are  reduced  to  a  minimum;  and 
the  classroom  work  revolves  almost  entirely  around  assigned 
questions  and  problems.  The  reason  for  this  lies  in  the  writer's 
belief  that  proficiency  in  accounting  can  come  only  through  prac- 
tice, and  that  the  usual  theoretical  classroom  lectures  or  discus- 
sions are  largely  a  waste  of  time.  Sufficient  questions  and  prob- 
lems have,  therefore,  been  included  here  to  present  concrete 
situations,  possible  of  variation  by  the  teacher,  which  may  be- 
come the  basis  of  profitable  class  discussion.  Moreover,  the 
many  questions  and  problems  included  will  permit  the  assign- 
ments to  be  varied  from  year  to  year. 

Naturally,  all  books  are  susceptible  of  improvement,  and  if 
any  important  principle  or  problem  in  general  advanced  account- 
ing has  not  been  covered,  the  author  would  be  pleased  to  have 


PREFACE 


Vll 


his  attention  directed  to  the  omission.  Finally,  he  would  be 
most  grateful  for  any  suggestions  for  the  improvement  of  the 
material  herein  presented  in  order  that  students  hereafter  using 
this  book  may  derive  therefrom  the  greatest  possible  practical 
benefit. 


Syracuse,  N.  Y. 
September,  1922. 


George  E.  Bennett. 


CONTENTS 


T^  Paos 

Preface  

CHAPTER  I.— Single  and  Double-Entry:  Principles  and  Terms  1 
Introduction— Accountancy  Versus  Accounting;  Auditing— Single- 
Entry  Bookkeeping— Internal  Check— Double-Entry  Bookkeep- 
ing—Classification of  Accounts— Suspense  Accounts— Ledger  Ar- 
rangement of  Accounts— Status  of  Journalization;  Journals— 
Ledgers— Adjustment  Account— Vouchers— Voucher  System— Trial 
Balance— Blocking  the  Ledger— Articulation  Statement:  Abstract- 
ing Accounts— Financial  Statements— Types  of  Assets— Types  of 
Liabilities— Two  Bases  of  Accounting— Deferred  and  Contingent 
Items— Capital  Versus  Deficit— Income ;  Revenue;  Earnings- 
Profit:  Gross,  Net,  Operation,  Capital— Receipts :  Disbusements ; 
Expenses,  Expenditures. 

CHAPTER  II.— Specific  Real  and  Nominal  Accounts 26 

Introduction— Cash  and  Cash  Records— Statement  of  Cash  Re^ 
ceipts  and  Disbursements— Notes  Versus  Bills— Notes  Receiv- 
able—Dishonored Notes  Receivable— Notes  Receivable  Discounted 
—Loss  on  Notes  Receivable— Notes  Receivable  Register— Interest 
and  Discount  on  Notes  Receivable— Accounts  Receivable— Bad 
Debts;  Reserve  for  Bad  Debts— Average  Due  Date— Capital  and 
Fixed  Assets— Repairs,  Renewals,  Replacements,  Additions,  Bet- 
terments—Wasting  Assets— Land— Leaseholds— Buildings— Machin- 
ery—Tools— Patterns— Good  Will,  Patents,  Royalties,  Copyrights, 
Trademarks,  etc.— Notes  Payable— Purchases— Sales— Sales  to  For- 
eign Branches— Returns  and  Allowances;  Expenses  Related  to 
Goods— Turnover— Insurance— Co-insurance  and  Fire  Loss— Mis- 
cellaneous Insurance  Procedures. 

CHAPTER  III.— Partnerships;    Ventures;    Contracts;    Manufac- 
turing Control 

Introduction— Partnership  Formation— Partnership  Defined— Part- 
nership Advantages  and  Disadvantages-Classifications  of  Partnere 
and  Partnerships— Provisions  of  Partnership  Agreement— Rights 
Duties,  and  Powers  of  Partners— Interest ;  Salaries;  Profits  and 
Losses;  Court  Rules— Opening  Entries— Partnerehip  Operation- 
Partnership  Profits-Interest  on  Capital  Contributions-Partner- 
ship Dissolution-Asset  Apphcation  Upon  Dissolution-Joint  Ven- 

UE 


60 


CONTENTS 


\\ 


Pagb 


ture  Defined— Venture  Entries— Accounts  Related  to  Contracts- 
Contracts  Upon  the  Balance  Sheet — Entries  Upon  Contractor's 
Records — Entries  Upon  Records  of  Contract  Customer — Purpose 
of  Discussion — Manufacturing  Accounts — Cost  Accounting  De- 
fined— Cost  Methods  and  Factory  Orders — Methods  of  Control — 
Control  Entries. 

CHAPTER  IV. — Corporations:  Definitions;  Opening  Entries  .  .  92 
Introduction — Corporation  Defined — Corporation  Distinguished 
from  Partnership — Corporation  Distinguished  from  Joint  Stock 
Company — Advantages  of  the  Corporate  Form  of  Organization — 
Disadv^antages  of  the  Corporate  Form  of  Organization — Classifica- 
tion of  Corporations — Incorporation  Procedure — Stockholders — 
The  Corporate  Charter — Capital  Versus  Capital  Stock — Capital 
Stock  Values— rPrimary  Classes  and  Kinds  of  Capital  Stock  with 
Par  Value:  Common  versus  Preferred — Sundry  Classes  and  Kinds 
of  Capital  Stock  with  Par  Value — Capital  Stock  Issuance  and 
Mode  of  Payment — Fully  Paid  and  Partly  Paid  Capital  Stocks- 
Stock  Subscriptions — Stock  Certificates — Issued  and  Unissued  Cap- 
ital Stock — Stock  ledger — Opening  Entries — Stock  Issued  for 
Money  Only:  Fully  Subscribed:  One  Class — Partly  Subscribed: 
More  Than  One  Class — Fully  Subscribed:  Issuance  on  Installment 
Plan — Stock  Issued  for  Both  Money  and  Notes :  Partly  Subscribed 
— Organization  Expense — Capital  Stock  Premium  and  Discount — 
Treasury  Stock:  Definition  and  Status — Accoimting  Treatment  of 
Treasury  Stock:  Donated  Stock — Accoimting  Treatment  of  Treas- 
ury Stock:  Purchased  Stock. 

CHAPTER    V. — Corporations:     Organization;     Records;     Opening 

Entries   (Continued) 137 

Genesis  of  a  Proposed  Corporation — Filing  the  Certificate  of  In- 
corporation— Amending  the  Certificate  of  Incorporation;  Rein- 
corporation— First  Regular  Meetings — Corporate  Officers — Cor])0- 
rate  Records — Minute  Book — Subscription  List  or  Register;  Sub- 
scription Ledger — Instalment  List — Instalment  Receipt  or  Scrip 
Book — Stock  Certificate  Book — Stock  Ledger  or  Book — Stock 
Journal — Stock  Transfer  Book — ^Bond  Register — New  York  Stock 
Exchange — Stock  Issued  for  Property — Transfer  of  the  Business 
of  a  Sole  Trader  to  a  Corporation — Procedure  by  Vendor  Upon 
the  Sale  of  the  Business  of  a  Sole  Trader  or  of  a  Partnership  to  a 
Corporation — Transfer  of  the  Business  of  a  Partnership  to  a  Corp- 
oration— No  Par  Value  Capital  Stock — Conclusion. 

CHAPTER  VI.— Investments:  Stocks,  Bonds  and  Mortgages  .     .  178 
Introduction — Investments  in   General — Investments  Other  Than 
Securities — Accoimting  for  Real   Estate   Investments — Bond   De- 


CONTENTS 


Paqb 


fined— Classification  of  Bonds— Bond  and  Mortgage— Registered 
Bonds— Coupon  Bonds— Mortgage  Bonds— Collateral  Trust  Bonds 
—Miscellaneous  Classes  of  Bonds— Loans  Secured  by  Collateral- 
Stock  and  Bond  Values— Proprietorship  versus  Loan  Investments 
—Speculative  versus  Non-Speculative  Investments:  Temporary 
versus  Permanent— Bonds  as  Investments— Accounting  for  Bonds 
as  Investments:  Simple  Procedure— Bond  Premium  and  Discount; 
Nominal  and  Effective  Interest  Rates;  Amortization  and  Accumu- 
lation—Ascertaining Present  Value  of  a  Bond— Schedule  of 
Amortization— Accounting  for  Bonds  as  Investments:  Amortiza- 
tion Principle. 

CHAPTER  VII.— Depreciation ;  Reserves  and  Reserve  Funds;  Sur- 
plus and  Dividends 212 

Introduction— Underiying  Principle— Depreciation  Defined— Fluc- 
tuation—Appreciation— Maintenance— Causes    of    Depreciation- 
Contingent    Losses    as    Depreciation— Depreciation  an  Operating 
Expense:   a  Manufacturing  Cost— Factors  Considered  in  Deter- 
mining   Depreciation    Amount— Methods    of    Determining    De- 
preciation Charges— Straight  Line  Method— Fixed  Percentage  on 
Diminishing  Value  Method— Depreciation  Fund— Sum  of  the  Year 
Digit    Method— Sinking    Fund    Method— Annuity    Method— Re- 
valuation   Method— Composite    Life    Methods— Working    Hours 
Method— Production  or  Output  Method— Miscellaneous  Methods 
—Fallacy  in   Theoretical   Depreciation   Discussion— Depreciation 
Rates— Booking  Depreciation— Replacing   or  SeUing   Depreciated 
Assets— Wasting    Assets— Appraisals    and    Depreciation— Reserve 
Defined— Valuation  Reserves— Surplus  or  True  Reserves:  Proprie- 
torship Reserves— Reserves  and  the  Balance  Sheet— Funds— Re- 
serve Funds— Secret  Reserves— Corporate  Net  Worth— Classes  of 
Dividends— Capital  versus  Profits ;   Relation  to  Dividends— Sur-    . 
plus    Profits— Illegal    Dividends— Mining    Company    Dividends- 
Realizing  Upon  Assets  to  Pay  a  Dividend— Declaring  and  Pay- 
ing Dividends— Stock  and  Scrip  Dividends— Cumulative  Dividends 
— Profit-sharing. 

CHAPTER  VIII. — Corporate  Obligations:  Bonds  Payable;  Sinking 

Fund 256 

Forms  of  Corporate  Obligations— The  Trustee  and  the  Trust 
Agreement— Trustee's  Certificate— Compliance  with  Statutes- 
Bond  Signatures— Listing  Bonds  on  the  Exchange— Unissued 
Bonds  and  Treasury  Bonds— Entries  Covering  the  Issue  of  Bonds- 
Illustrative  Problem  and  Solution— Payment  of  Bond  Interest- 
Bond  Interest  and  Construction— Bond  Premium,  Discount,  and 
Expense— Sinking  Fund— Sinking  Fund  Trustee— Illustrative 
Problems  and  Solutions— Annuities  and  Sinking  Funds— Cancella- 
tion of  Redeemed  Bonds  and  Paid  Coupons. 


xu 


CONTENTS 


i 


Paob 
CHAPTER  IX.— Balance  Sheet;  Profit  and  Loss  Statement  .  .  292 
Introduction— Preliminary  Suggestions— Balance  Sheet  Titb>— 
Balance  Sheet  Form— Arrangement  of  Balance  Sheet  Items;  Ac- 
count Form  of  Statement— Nomenclature  for  Balance  Sheet  CUi>- 
tions — Current  Assets:  Cash— Notes,  Acceptances,  and  Accounts 
Receivable — Short  Term  Investments — Accrued  Interest — Invtm- 
tories— Investments— Sinking  Fund— Properties— Goodwill,  Pat- 
ents, etc.— Deferred  Charges— Current  Liabilities:  Notes  and  Ac- 
ceptances Payable — Accounts  Payable — Dividends  Payable — 
Wages,  Taxes,  and  Interest  Accrued— Fun(l(d  Debt— Deferred 
Credits — Reserves — Capital  Stock — Surplus — Contingent  Assets 
and  Liabilities — Capital  versus  Revenue--Stat(>ment  of  Profit  and 
Loss  Title— Arrangement  of  Statement  of  Profit  and  Loss  Items- 
Gross  Sales— Deductions  from  Sales— Net  Sales — Cost  of  Goods 
Sold;  Cost  of  Manufacture  and  of  Manufactured  Product  Sold— 
Gross  Profit  on  Sales— SelHng  Expenses— Selling  Profit— General 
Expenses— Profit  from  Operations— Additional  Income— Gross  In- 
come— Deductions  from  Income — Net  Income  and  Surplus  at  Be- 
ginning of  Period— Profit  and  Loss  Credits— Surplus  at  End  of  I*e- 
riod— Comparative  Statements;  Statement  Statistics— Illustrative 
Problem   and  Solution. 

CHAPTER  X.— Statement  Analysis:  For  Credit  Purposes  ....  340 
Introduction — Credit — Personal  versus  Mercantile  Credit— The 
Credit  Department  and  Credit  Information— Borrowers'  State- 
ments—The Audited  Balance  Sheet— Credit  and  the  Balance 
Sheet — The  Problem  of  Current  Financing — General  Principles  of 
Analysis:  Further  Discussion— Cash— Notes  or  Bills  Receivable— 
Acceptances— Accounts  Receivable— Inventories :  Materials,  Sui> 
plies  and  Merchandise— Consignment  Accounti^— Accrued  Items  as 
Current  Assets— Deferred  Charges  as  Current  Assets— Miscellane- 
ous Items  Considered  as  Current  Assets— Capital  or  Fixed  Assets- 
Liability  Analysis:  in  General— Notes  or  Bills  Payable— Accounte 
Payable — Capital  or  Fixed  Liabihties— The  Comparative  Balance 
Sheet— The  Statement  of  Fund  Application— The  Income  Stat^ 
ment. 

CHAPTER  XL— Statement  Analysis    (Continued):    For   Invest^ 

ment  Purposes 359 

Introduction— Large  versus  Small  Scale  Enterprises— General  Fac- 
tors of  Investment  Importance— Publicity  Through  Pubhshed 
Statements— Fire  Insurance  and  Corporate  Assets— Fixed  or  Cap^ 
ital  Assets— Land— Buildings —Machinery  and  Machine  Tools- 
Furniture  and  Fixtures— Dehvery  Equipment— Drawings,  Models, 
Patterns,  etc.— Goodwill— Patents,  Trademarks,  etc.— Treasury 
Stock  and  Bonds— Investments— Current  Assets— Sinking  and 
other  Special  Funds— Bonded  Indebtedness— Current  Liabihties— 


CONTENTS 


xm 


Pacub 


Capital  Stock— Changing  the  Capitalization  Form— Reserves- 
Surplus— Income  Statement:  Margin  of  Safety:  Average  Profits- 
Illustrative  Problem  and  Solution— Statement  of  Resources  and 
Their  Apphcation— Illustrative  Problem  and  Solution. 

CHAPTER  XII. — Mergers  versus  CoNSOLroATioNs 399 

Corporate  Combinations— Advantages  of  Corporate  Combination 
—Combination  Methods— Merger  versus  Consolidation:  General- 
New  York- Illustrative  Merger  Problem:  General— New  York- 
Basis  of  Consolidation:  Preliminary  Investigation— ConsoHdation 
Capitahzation— CapitaHzation  on  Basis  of  Earning  Power— Means 
Used  for  Paying  off  Interests— Illustrative  Methods  of  Determin- 
ing Capitahzation:  Goodwill— Illustrative  ConsoHdation  Problem: 
General   Entries. 

CHAPTER   XIII.— Parent    versus    Holding    Companies;    Consoi/- 

idated  Statements 431 

Introduction— Mergers  and  ConsoHdations  versus  Parent  and 
Holding  Companies— Parent  Company  Accounting— Holding  Com- 
pany Accounting— Consolidation  of  Balance  Sheets  versus  Con- 
solidated Balance  Sheets— Law  and  Accounting  as  Related  to  Con- 
solidated Statements— Information  Not  Disclosed  Except  by  Use 
of  Consohdated  Statements— Carrying  Investment  at  Actual  Value 
—Intercompany  Accounts— Intercompany  Sales— Profits  Earned 
Prior  to  Date  of  Purchase— Premium  and  Discount  on  Investment 
—Goodwill  on  the  Consohdated  Balance  Sheet— Minority  Inter- 
ests in  general— Intercompany  Sales  and  Minority  Interests- 
Alternate  Form  of  Consolidated  Balance  Sheet— Consohdated  In- 
come Statement:  Content— Illustrative  Problems:  Consohdated 
Balance  Sheets. 

CHAPTER  XIV.— Fiduciary  Statements 453 

Introduction— Further  Definitions,  Terms,  and  Distinction^ 
Courts  of  Competent  Jurisdiction— Duties  of  an  Executor  or 
Administrator— Will  Admitted  to  Record  or  Probate— Estate  As- 
sets—Collection and  Care  of  Assets— Estate  Debts— Estate  Book- 
keeping—Principal (con)us)  versus  Income— Executor's  Account- 
ing to  the  Court— Commissions— Final  Duties— Illustrative  Prob- 
lem: Apphcation  of  Double  Entry  Principles:  Charge  and  Dis- 
charge Statement  with  Schedules— Trusts— Duties  of  Trustees- 
Relation  Between  Work  of  Executor,  Administrator,  and  Trustee 
—Life  Tenant  versus  Remainderman— Distinctions  Relating  to  In- 
come—Distinctions Relating  to  Principal  (corpus). 

CHAPTER  XV.— Fiduciary  Statements   (Continued) 495 

Introduction— Insolvency  versus  Bankruptcy— Equity  Receiver^ 
ships— Procedure  in  Event  of  Financial  Embarrassment— Assign- 


lav 


CONTENTS 


Page 


# 


ments  in  favor  of  Creditors— Effect  of  National  Bankruptcy  Act 
Upon  Assignments— Bankruptcy.  Receiver  versus  Trustee  in 
Bankruptcy— Trustees  in  Bankruptcy— Content  of  Bankruptcy 
Statements— Illustrative  Problem:  Receivership— Statement  of 
Affairs  with  Accompanying  Deficiency  Account— Illustrative  Prob- 
lem: Statement  of  Affairs  and  Deficiency  Account. 

CHAPTER  XVI.— Fiduciary  Statements    (Continued) 518 

Introduction— Basic  Distinctions  Reviewed— Receivership  Ac- 
counting—Realization and  Liquidation— Simple  Realization  and 
Liquidation — Realization  and  Liquidation  Accompanied  by  Activ- 
ities of  Trading  or  Operation— Statement  of  Realization  and 
Liquidation — Illustrative  Problems  and  Solutions. 

Questions  and  Problems 540 

Index 651 


I 


ADVANCED  ACCOUNTING 

CHAPTER  I 

SINGLE  AND  DOUBLE-ENTRY:  PRINCIPLES 

AND  TERMS 

Introduction.— rThe  purpose  of  this  chapter  is  to  present  a, 
summary  review  ^f  some  of  the  more  important  points  presuma- 
bly discussed  in  the  accounting  work  of  the  first  year.  If  an 
elaboration  be  desired,  the  student  should  refer  back  to  his  first- 
year  material: 

Accounta^icy  Versus  Accounting;  Auditing. — Account- 
ancy is  a  profession  having  to  do  with  the  recording,  verification 
and  presentation  of  facts,  involving  the  acquisition,  production, 
conservation  and  transfer  of  values.  It  "comprehends  the  con- 
duct of  audits,  examinations,  and  investigations;  devising  and 
installing  systems;  criticizing  organizations  and  management; 
an4  in  some  cases  efiiciency  work.'' 

Accounting  is  the  science  which  treats  of  the  systematic  record, 
compilation  and  presentation  in  a  comprehensive  manner  of  the 
financial  operations  of  a  business. 

Auditing  is  the  art  of  verifying  the  work  done  in  recording, 
compiling,  and  presenting  the  facts  concerned  with  business 
transactions,  to  the  end  that  all  possible  information  concerning 
the  value  and  potentialities  of  the  reviewed  business  may  be 
presented  correctly  in  the  form  of  two  basic  statements,  with 
their  accompanying  comment: 

1.  Balance  Sheet 

2.  Profit  and  Loss  Statement. 

Single-entry  Bookkeeping. — Bookkeeping  may  be  consid- 
ered as  the  art  of  keeping  a  systematic  record  of  business 
transactions.  Practically,  there  exist  only  two  systems  by  means 
of  which  this  systematic  record  is  compiled;  these  have  been 
named: 

1 


n 


2  ADVANCED  ACCOUNTING 

1.  Single-entry.  Practically,  the  accountant  is  more  likely  to 
consider  single-entry  bookkeeping  as  representing  a  lack  of 
system  rather  than  as  a  system.  If  any  system  exists,  it 
is  due  to  the  fact  that  double-entry  has  crept  in,  to  some 
extent. 

2.  Double-entry. 

Under  single-entry,  equal  charges  and  credits  are  not  required 
for  every  exchange  of  values: 

1.  In  its  simplest  form,  a  record  is  kept  of  transactions  with 
persons  (customers,  creditors,  proprietor!,  and  perhaps  with 
cash,  merchandise,  and  certain  miscellaneous  items  of  in- 
terest to  the  proprietorship  element.  Since  few,  if  any, 
impersonal  accounts  are  used,  provision  is  not  made  for 
securing  a  Trial  Balance,  or  for  obtainmg  a  check  on  the 
accuracy  of  the  work  done  upon  the  accounting  records. 

2.  In  its  more  complicated  form,  it  might  be  any  system  of 
record  keeping  in  which  there  is  a  lack  of  balance  between 
the  debit  and  credit  entries;  therefore,  a  single-entry  sys- 
tem, if  considered  as  a  system,  may  be  more  complicated 
and  more  highly  technical  than  a  double-entry  system. 

Single-entry  may  be  considered  as  the  first  step  in  account- 
keeping  development  after  the  element  of  credit  was  introduced 
into  business  dealings.  When  business  transactions  were  entirely 
upon  a  cash  basis,  account  books  were  unnecessary,  even  a  Cash 
Book.  If  an  occasional  credit  transaction  occurred,  the  creditor 
merely  made  out  a  memorandum  of  some  sort  which  he  held 
until  the  debtor  paid,  after  which  it  was  destroyed.  Likewise, 
when  the  creditor  above  mentioned  became  a  debtor  on  account, 
a  similar  memorandum  was  used  to  act  as  a  reminder  of  such 
fact. 

An  increasing  number  of  credit  transactions  made  it  difficult 
for  a  record  of  them  to  be  kept  upon  a  mere  memorandum  basis. 
Therefore,  the  first  book  record  came  into  use  in  which  these 
memos  were  entered.  Since  the  entries  therein  were  made 
daily,  this  record  became  known  as  the  Day  Book.  Cancellation 
of  the  entries  therein  made  was  effected  by  writing  *Taid"  across 
them.  As  long  as  the  merchant  "carried  on"  only  in  a  small 
way,  doing  everything  himself,  the  Day  Book  was  all-sufficient. 
But  as  soon  as  he  found  it  necessary  to  have  a  clerk  who  handled 
any  money  for  him,  he  found  it  desirable  and  even  necessary  to 


I 


SINGLE  AND  DOUBLE-ENTRY  3 

keep  some  sort  of  a  cash  record;  hence,  the  introduction  of  the 
Cash  Book,  in  its  crudest  form.  Some  would  maintain  that  such 
a  Cash  Book  was  in  its  simplest  form  but,  in  the  light  of  present 
existing  methods  of  accounting  tending  toward  efficiency  and 
labor  reduction,  the  opinion  is  ventured  that  today  this  crude 
form  of  Cash  Book, — containing,  say,  merely  the  names  of  per- 
sons from  whom  money  was  received  and  the  amounts  of  the 
daily  cash  sales  on  one  side,  offset  on  the  other  side  by  entries 
covering  either  the  various  things  paid  for  in  cash  or  persons  to 
whom  cash  was  paid,— is  not  to  be  considered  as  the  simplest 
form  but  the  most  complicated  form  which  it  is  possible  to  use. 
Subsequently,  as  credit  transactions  further  increased  in  num- 
ber, the  Day  Book  became  entirely  inadequate  as  a  medium  from 
which  one  could  ascertain  readily  how  much  each  customer  owed, 
when  one  customer  purchased  several  bills  of  goods  at  different 
times  without  paying  for  them.  The  result  was  that  a  new 
record  came  to  be  used,  in  which  each  customer  was  given  a 
page;  this  was  the  Ledger.  In  addition  to  the  customers'  ac- 
counts, the  accounts  with  creditors  were  contained  therein.  Like- 
wise, the  proprietor  being  interested  in  what  he  himself  had 
received  from  his  enterprise,  either  in  the  way  of  cash  or  goods, 
was  likely  to  keep  an  account  in  this  Ledger  with  his  drawings. 
The  result  was,  as  indicated  already,  that  these  accounts  were 
the  only  ones  essential  to  single-entry,  and  were  all  personal  in 
their  nature.  Other  accounts,  kept  upon  such  a  Ledger  for  infor- 
mational purposes,  were  only  of  a  memorandum  nature,  without 
having  any  particular  connection  with  the  general  scheme  of 
accounts. 

The  only  possible  advantage  a  single-entry  system  could  have 
would  be  simplicity,  and  simplicity  does  not  exist  in  such  a 
complicated  form  of  record.  Its  disadvantages  may  be  sum- 
marized as  imder: 

1.  Errors  that  arise  in  the  work  are  not  detected  readily,  since 
there  exists  no  positive  check  on  the  journalizing. 

2.  Since  nominal  accoimts  are  not  kept,  profits  and  losses  are 
not  shown. 

3.  A  Trial  Balance  cannot  be  secured  without  rewriting  the 
books,  at  least  upon  working  papers. 

4.  A  system  of  internal  check  is  lacking. 


^ 


4  ADVANCED  ACCOUNTING 

Although  a  single-entry  system  in  its  more  simple  form  often 
is  installed  on  purpose,  as,  say,  in  a  small  retail  or  commission 
business,  in  a  professional  man^s  office,  in  a  charitable  institu- 
tion, and  for  a  trusteeship,  reasonable  doubt  exists  as  to  whether 
such  simplicity  overshadows  the  marked  advantages  of  even  a 
simple  double-entry  system  for  the  same  case. 

The  usual  statements  prepared  under  single-entry  are: 

1.  Statement  of  Assets  and  Liabilities. 

2.  Statement  of  Profit  Determination. 

The  former  has  the  appearance  of  a  Balance  Sheet  but  is  not 
one,  since  not  prepared  from  double-entry  books.  The  latter  is 
not  the  double-entry  Profit  and  Loss  Statement,  since  this  cannot 
be  prepared,  unless  the  accounts  are  recast,  because  singhi-entry 
does  not  maintain  nominal  accounts.  The  single-entry  method 
of  calculating  profits  revolves  around  three  classes  of  items: 

1.  Comparative  net  worths. 

2.  Interim  drawings. 

3.  Interim  investments. 

In  a  later  chapter,  the  Statement  of  Resources  and  Their 
Application,  ofttimes  used  in  single-entry,  will  be  considered  in 
connection  with  another  topic. 

To  determine  the  profit  or  loss  under  single-entry  for  a  speci- 
fied period  of  time,  as  a  year,  it  is  necessary  to  ascertain  from 
all  sources  available  all  that  the  proprietor  owns  and  subtract 
from  the  total  of  such  ownings  the  total  of  all  he  owes.  Since 
what  a  person  owns  is  an  asset  and  what  he  owes  a  liability, 
this  method  of  profit  determination  is  known  generally  as  the 
*^asset  and  liability"  method.  The  difference  between  the  total 
assets  and  total  liabilities  represents  net  worth.  A  comparison 
of  the  amount  of  net  worth  at  the  end  of  the  year  with  its 
amount  at  the  beginning  of  the  year  represents  either  an  increase 
or  decrease  in  net  worth  during  the  elapsed  period  of  time.  This 
increase  or  decrease  in  net  worth  does  not,  necessarily,  represent 
the  net  profit  or  net  loss  for  the  year.  If  there  has  been  an 
increase,  such  increase  is  only  one  element  of  the  net  profit.  The 
total  profit  of  the  year  consists  of  two  elements: 

1.  Net  worth  net  increase, — ^the  amount  of  profit  left  in  the 
business  (ending  net  worth  adjusted  in  the  amount  of  the 
new  capital  introduced  during  the  year). 


SINGLE  AND  DOUBLE-ENTRY  5 

2.  Drawings,— the  amount  of  profit  taken  out  of  the  business. 

Again,  with  a  net  worth  net  decrease,  a  profit. may  have  been 
made.  Because  of  these  possibilities,  the  asset  and  liability 
method  of  profit  determination  operates  about  as  follows: 

1.  Determine  net  worth  at  the  beginning  of  the  year. 

2.  Determine  net  worth  at  the  end  of  the  year. 

3.  Determine  difference  between  (1)  and  (2),  this  being  either 
an  increase  or  decrease  in  net  worth. 

4.  Add  to  increase  in  net  worth,  or  deduct  from  decrease  in 
net  worth,  the  proprietor's  drawings  during  the  year. 

5.  Deduct  from  increase  in  net  worth  or  add  to  decrease  in  net 
worth  introductions  of  capital  by  proprietor  during  the  year. 

6.  Resultant  amount  represents  either  the  total  profit  or  total 
loss  for  the  year. 

Since  in  single-entry  it  is  not  possible  to  set  up  a  Profit  and 
Loss  account,  and  the  net  worth  comparison  is  the  only  expedient 
by  means  of  which  the  profit  or  loss  may  be  determined,— no 
second  method  existing  by  means  of  which  evidence  may  be 
secured  as  to  the  accuracy  of  the  results  determined,— as  in 
double-entry  (see  second  section,  post) ,— the  greatest  of  care  is 
necessary  in  preparing  single-entry  statements. 

In  changing  from  single-entry  to  double,  the  steps  in  summary 
form  would  be  about  as  follows: 

1.  Adjust  the  capital  accounts  to  take  up  the  profit  or  loss  for 
the  period. 

2.  If  same  books  are  to  be  used: 

a.  Prepare  Statement  of  Assets  and  Liabilities  and  journal- 
ize; and  post  to  the  Ledger  only  those  accounts  not  at 
present  thereon  (in  Ledger). 

3.  If  new  books  are  to  be  used: 

a.  Prepare  Statement  of  Assets  and  Liabilities  and  journal- 
ize; and  post  to  the  Ledger  all  the  accounts  appearing 
in  such  statement. 
Internal  Check. — It  is  stated  by  most  accountants  that  three 
of  the  objects  of  an  audit  contemplate: 

1.  Discovering  errors  of  principle. 

2.  Eliminating  mechanical  errors. 

3.  Detecting  fraud. 

Internal  check  is  a  method  under  which  one  employee  checks 


6  ADVANCED  ACCOUNTING 

the  work  of  another  so  that  the  entire  control  of  a  system  does 
not  rest  upon  any  one  clerk,  as  to  certain  elements  concerning 
which  the  probability  of  fraud  exists.  Since  under  a  system  of 
internal  check  the  probability  of  fraud  is  reduced,  the  amount 
of  routine  detailed  checking  that  otherwise  must  be  done  is 
lessened.  As  cash  and  goods  are  the  two  assets  most  easily 
appropriated  to  one's  fraudulent  use,  the  system  of  internal  check 
must  cover  all  angles  of  each  case  thoroughly;  for  example: 

1.  As  to  cash: 

a.  Incoming  mail  opened  and  the  cash  therein  listed  upon  a 
Cash  Sheet  by  some  one  other  than  the  cashier  or  })ook- 
keeper. 

b.  All  receipts  to  be  deposited  in  bank  intact. 

c.  Cash  payments  made  by  check,  each  supported  by  a  duly 
authorized  voucher. 

d.  Small  payments  made  from  a  petty  cash  fund  operated 
on  the  imprest  basis. 

e.  Cashier  should  not  have  access  to  the  customers*  I^edgers 
and  to  the  bills  submitted  customers. 

f.  Payrolls  should  be  carefully  provided  for.  Changes  in 
pay  rates  must  be  only  upon  written  authority;  the 
checking  of  each  step  in  a  payroll  preparation  should 
be  by  one  not  directly  in  charge  of  the  work;  paymenta 
should  be  made  in  the  presence  of  a  witness  who,  with 
the  paymaster,  should  sign  the  payroll. 

2.  As  to  goods: 

a.  Safeguard  purchases  by  proper  records  of  receipts  and 
filled  orders. 

b.  Proper  checking  of  purchase  invoices  as  to  number  and 
quality  of  items  received,  extensions,  and  prevention  of 
duplicate  payments. 

c.  Proper  checking  of  sales  invoices,  plus  comparison  with 
customers'  orders. 

d.  Prepare  correct  records  of  all  orders  received  and  ship- 
ments made. 

e.  Prepare  correct  records  of  returned  goods, — ^purchases 
and  sales. 

f.  Allowances  should  be  granted  only  upon  authority. 

g.  Proper  inventory  records  should  be  maintained. 


SINGLE  AND  DOUBLE-ENTRY  7 

Other  points  might  be  mentioned  in  connection  with  the  above, 
say,  as  to  expenses,  but  the  illustrations  given  seem  sufficient. 

Double-entry  Bookkeeping.— Under  this  system  a  complete 
record  of  every  business  transaction  is  kept  showing  its  effect 
upon  both  real  and  nominal  accounts.  It  is  based  upon  the 
principle  that  for  each  business  transaction  there  must  be  an 
equal  debit  and  credit,  by  means  of  which  a  constant  equilibrium 
is  maintained.  At  the  inception  of  a  business  enterprise,  the 
initial  equation  is  established  that  Assets  =  Liabilities  plus 
Capital.  This  equation  is  reflected  in  the  set  out  of  the  accounts 
upon  the  Ledger.  Each  subsequent  business  transaction  affects 
both  sides  of  the  equation  so  that,  no  matter  what  transactions 
occur,  the  equilibrium  originally  established  will  not  be 
destroyed. 

The  advantages  of  double-entry  may  be  summarized  as  under: 

1.  A  Trial  Balance  may  be  prepared  from  the  Ledger  by 
means  of  which  the  accuracy  of  the  postings  and  the 
equilibrium   of  the   accounts   may   be   determined. 

2.  A  Profit  and  Loss  Statement  may  be  prepared  without  re- 
casting the  accounts. 

3.  Balance  Sheet  proof  exists  as  to  the  correctness  of  the  Profit 
and  Loss  Statement. 

4.  Etc.,  etc. 

The  asset  and  liability  method  of  profit  determination  may  be 
used  in  connection  with  double-entry  books  of  account,  by  com- 
paring one  with  the  other,  the  Balance  Sheets  at  the  beginning 
of  the  year  and  at  the  end  of  the  year.  However,  in  double- 
entry,  since  the  Balance  Sheet  is  evidence  of  the  correctness  of 
the  Profit  and  Loss  statement,  it  is  unnecessary  to  resort  to  the 
asset  and  liability  method  of  profit  determination  thereunder. 

Double-entry  requires  more  books  than  does  single-entry,  at 
least  to  the  extent  of  the  Journal,  this  being  the  only  additional 
book  absolutely  essential. 

Classification  of  Accounts. — ^An  account  records  under  a 
specific  heading  either  similar  or  dissimilar  items  relating  to 
the  same  person  or  thing.  Each  account,  for  convenience,  is 
divided  into  two  portions  imder  each  of  which  similar  items  are 
grouped,  and  each  such  portion  is  opposed  to  the  other.  Because 
of  this  and  grounded  upon  the  basic  equation,  the  rules   for 


I 


8 


ADVANCED  ACCOUNTING 


journalizing  or   entering  transactions   into   accounts,  may   be 
stated  as: 


Debit: 

1.  Increase  in  assets 

2.  Decrease  in  liabilities 

3.  Decrease  in  proprietorship 


Credit: 

1.  Decrease  in  assets 

2.  Increase  in  liabilities 

3.  Increase  in  proprietorship 


Basically,  accounts  are  divided  into  two  general  classes: 

1.  Real — Balance  Sheet  accounts — assets,  liabilities,  and  vested 
proprietorship;  accounts  that  represent  things  which  have 
actual,  tangible  existence. 

2.  Nominal — Profit  and  Loss  accounts — income  and  expenses. 
These  accounts  represent  increase  or  decrease  of  net  worth ; 
they  are  closed  into  the  Revenue  account, — Profit  and  Loss 
account, — ^the  final  result  of  which  sets  out  in  one  account 
either  net  profit  or  net  loss. 

Other  classes  of  accounts  often  referred  to  may  be  sot  out 
about  as  follows: 

1.  Personal — accounts  with  persons,  as  the  various  people  or 
corporations  with  whom  business  dealings  are  made. 

2.  Impersonal — accounts  other  than  personal,  as  those  rec^ord- 
ing  profits,  losses,  receipts,  disbursements,  and  non-personal 
assets  and  liabilities. 

3.  Mixed — accounts  containing  elements  both  real  and  nomi- 
nal, as  Merchandise. 

4.  Primary  (or  major) — accounts  in  which  are  recorded  all 
transactions  of  a  particular  class;  the  General  Ledger, 
more  and  more,  is  becoming  a  Ledger  of  primary  ac- 
counts. 

6.  Subsidiary — accounts  auxiliary  to,  even  though  not  neces- 
sarily dependent  upon,  a  primary  account. 

6.  Summary — accounts  in  which  are  simimed  up  the  data  con- 
tained in  a  number  of  other  accounts  of  different  classes. 

7.  Controlling — accounts  containing  the  totals  of  the  debits 
and  credits  of  a  munber  of  so-called  detail  accounts  so  that 
the  balance  of  the  aggregate  of  these  accounts  may  be  dis- 
played at  any  time.  Controlling  accounts  are  not  summary 
accounts,  as  the  latter  collect  dissimilar  accounts,  whereas 
controlling  accounts  collect  amounts  of  similar  accounts. 

8.  Collective— See  (7). 


SINGLE  AND  DOUBLE-ENTRY 


9 


Suspense  Accounts. — ^Usually,  such  accounts  record  items 
temporarily  pending  the  determination  of  their  final  disposition, 
as: 

1.  Unlocated  Trial  Balance  errors. 

2.  Cash  received  with  name  of  sender  not  available. 

3.  Differences  existing  between  a  Cash  Book  and  the  bank's 
records. 

4.  Items,  the  proper  treatment  of  which  is  at  present  question- 
able. 

One  such  account  should  be  used  for  each  suspense  item.  Sub- 
sequently, if  such  account  cannot  be  cleared  into  its  proper  place, 
its  ultimate  destination  should  be  into  the  Profit  and  Loss  ac- 
count. However,  in  the  interim,  its  amount  should  be  carried 
upon  the  Balance  Sheet;  this  would  be  especially  true  where  a 
C.  P.  A.  problem  is  encountered  that  is  out  of  balance.  The 
suspense  item  should  be  carried  as  a  deferred  charge. 

Doubtful  accounts  and  notes  receivable  may  be  carried  in  a 
Suspense  Ledger,  so-called.  This  is  perfectly  proper,  but  care 
should  be  observed  to  make  certain  that  the  Reserve  for  Bad 
Debts  account  covers  this  amount. 

Ledger  Arrangement  of  Accounts. — ^Accounts  should  be 
arranged  upon  the  Ledger  so  that  the  preparation  of  the  financial 
statements  will  be  facilitated.  Ordinarily,  such  an  arrangement 
might  be  about  as  follows: 


First  arrangement: 

1.  Current  assets 

2.  Capital  assets 

3.  Current  liabilities 

4.  Capital  liabilities 

5.  Proprietorship 

6.  Income 

7.  Expenses 


Second  arrangement: 

1.  Capital  assets 

2.  Current  assets 

3.  Capital  liabilities 

4.  Current  liabilities 

5.  Proprietorship 

6.  Income 

7.  Exp>enses 


If  controlling  accounts  are  not  made  use  of,  the  customers'  and 
creditors'  accounts  would  be  carried  at  the  back  of  the  Ledger. 
Against,  or  contrary  to  either  of  the  above  arrangements,  the 
accounts  may  be  grouped  alphabetically  upon  the  Ledger. 

Again,  instead  of  merely  carrying  accounts  upon  a  Ledger  by 
name,  a  large  concern,  or  even  a  small  one,  is  apt  to  designate 
its  accounts  by  numbers  as  well  as  by  names.  In  such  event, 
any  one  of  many  systems  of  numbering  may  be  used.    However, 


i 


10 


ADVANCED  ACCOUNTING 


it  would  seem  advisable  hereunder,  although  not  ordinarily  done, 
to  make  sure  the  smaller  numbers  of  a  series  are  used  for  the 
accounts  to  which  reference  is  most  made.  For  example,  compare 
the  two  arrangements  submitted  below,  each  of  which  follows  a 
simple  numbering  scheme.  The  two  arrangements  cover  merely 
the  summary  groupings: 


First  arrangement: 

1.  Assets 

2.  Liabilities 

3.  Proprietorship 

4.  Income 


Second  arrangement: 

1.  Expenses 

2.  Income 

3.  Proprietorship 

4.  Assets 

5.  Liabilities 


5.  Expenses 

If  the  advantage  of  the  second  arrangement  over  the  first  one 
is  not  entirely  apparent  from  the  above,  consider  the  following 
numbering  scheme  in  connection  with  the  second  grouping: 

Nos. 


1-199 

Expenses 

200-299 

Income 

300-399 

Proprietorship 

400-499 

Assets 

500-599 

Liabilities 

From  the  above,  it  is  evident  that  the  expense  accounts,  used 
the  most  frequently,  will  carry  the  smaller  numbers. 

Before  passing  to  a  consideration  of  a  subdivision  of  any  gen- 
eral grouping  into  the  more  special  groupings,  the  following  basic 
arrangement  is  presented,  this  being  in  accord  with  the  summary 
form  of  Balance  Sheet  arrangement  shown  in  Chap.  9,  post: 


1.  Expenses 

2.  Income 

3.  Assets 

4.  Investments 


6.  Liabilities 

7.  Reserves 

8.  Capital 

9.  Surplus 


5.  Deferred  charges  and  credits 
The  general  account  groupings,  however  made,  may  be  subdi- 
vided as  desired  into  a  number  of  special  groupings. 


First  example: 
1     Expenses 

11  Operation 

111  Manufacturing 

112  Selling 

113  Administrative 

12  Non-operation 


Second  example: 

1-199    Expenses 

1-  99 

100-149 

150-174 

175-199 


Manufacturing 
Selling 

Administrative 
Non-operation 


In  connection  with  any  system  of  numbering,  it  seems  usual  to 


SINGLE  AND  DOUBLE-ENTRY 


11 


indicate,  at  times,  a  departmental  differentiation  by  means  of 
prefixing  a  letter  to  a  number  to  specify  to  what  department  an 
income  or  expense  item  belongs. 

Status  of  Journalization—Journals.— To  journalize,  is  to 
classify  systematically  the  debits  and  credits  arising  out  of  a 
business  transaction.  In  connection  with  this  topic,  the  follow- 
ing seem  axiomatic: 

1.  Since  all  records  of  original  entry  are  Journals,  all  entries 
are  journal  entries. 

2.  Since  it  is  necessary  to  keep  the  basic  accounting  equation 
always  in  balance,  the  sum  of  the  debits  must  equal  the 
sum  of  the  credits. 

Because  of  (1)  above,  the  direct  Ledger  closing  at  the  end  of 
a  period  would  seem  to  be  absolutely  in  error;  all  closing  entries 
should  be  entered,  preferably,  upon  the  Journal  and  be  posted 
therefrom  to  the  Ledger. 

Basically,  original  entries  are  made  upon  Journals,  regardless 
of  what  names  may  be  used  therefor,  and  postings  of  these  entries 
are  made  to  Ledgers.  Therefore,  the  basic  books  of  account 
would  be: 

1.  Journals  2.  Ledgers 

Some  bookkeepers  have  a  habit  of  making  monthly  summary 
entries  of  each  record  of  original  entry  upon  the  General  Journal 
and  of  posting  therefrom  to  the  General  Ledger.  This  practice 
seems  unnecessary  and  a  duplication  of  effort  in  that  since  all 
records  of  original  entry  in  which  entries  are  made  with  debit 
and  credit  distinctions  are  Journals,  the  monthly  postings  there- 
from to  the  General  Ledger  may  be  made  direct,  provided,  natu- 
rally, that  these  records  have  been  kept  properly. 

Ledgers.— Books  of  original  entry  contain  the  first  entry  of 
a  transaction,  the  record  being  written  up  in  the  order  in  which 
the  transactions  took  place,— in  the  order  of  the  dates  upon 
which  the  transactions  occurred.  On  the  other  hand.  Ledgers 
are  books  containing  the  accounts  to  which  these  Journal  entries 
are  transferred  (posted).  For  present  purposes,  all  Ledgers  may 
be  grouped  under  three  headings: 

1.  General  Ledger  3.  Private  Ledger 

2.  Subsidiary  Ledgers 

It  seems  unnecessary  to  discuss  any  of  these. 


I 


12 


ADVANCED  ACCOUNTING 


I 


Forms  of  Ledger  rulings  are  many,  their  use  being  dependent 
primarily  upon  desirability  and  utility.  However,  it  would  seem 
that,  unless  an  excellent  reason  exists  to  the  contrary,  the  Ledger 
ruling  should  follow  the  standard  form  which,  basically,  is  called 
the  T  form.  And  where  a  change  from  the  standard  ruling  ap- 
pears in  order,  it  would  seem  that  the  usual  differentiation  would 
consist  in  the  addition  of  one  or  more  ''balance"  columns  to  the 
standard  ruling. 

Because  of  the  fact  that  a  Ledger  is  not  a  book  of  original 
entry,  a  court  will  not  accept  it  as  evidence  unless  testimony  is 
offered  that  its  contents  have  been  verified  by  an  examination 
of  the  records  of  original  entry;  in  such  event,  it  will  be  con- 
sidered as  a  summary  or  abstract  of  the  books  of  original  entry. 

Adjustment  Account. — In  order  to  prove  the  accuracy  of  a 
subsidiary  Ledger  Trial  Balance,  ordinarily,  one  must  refer  to 
the  controlling  account  thereover  carried  upon  the  General 
Ledger.  Where  a  separate  bookkeeper  runs  a  subsidiary  Ledger, 
having  no  duties  in  connection  with  the  General  Ledger,  an 
expedient  is  resorted  to  by  means  of  which  this  bookkeeper  is 
not  required  to  consult  the  General  Ledger  to  prove  the  accuracy 
of  his  Trial  Balance.  The  subsidiary  Ledger  is  made  self- 
balancing  by  the  introduction  thereon  of  an  Adjustment  account. 
Such  account  is  an  exact  duplicate  of  the  controlling  account, 
but  set  up  in  reverse  order.  Items  posted  in  detail  to  the  debit 
of  the  separate  accounts  carried  on  the  subsidiary  Ledger  are 
posted  in  total  as  a  credit  to  this  Adjustment  account,  wliereas 
items  posted  in  detail  to  the  credit  of  the  separate  accounts 
carried  on  the  subsidiary  Ledger  are  posted  in  total  as  a  debit 
to  this  Adjustment  account.  The  Ledger,  therefore,  is  in  balance 
by  itself, — in  other  words,  it  is  a  self-balancing  Ledger. 

Vouchers. — Any  document  may  be  considered  as  a  voucher 
which  sufficiently  identifies  or  verifies: 

1.  The  correctness  of  charges  for  cash  paid  or  to  be  paid. 

2.  The  correctness  of  credits  for  cash  received  or  to  be  received. 
In  any  business  house  which  boasts  of  a  system  of  accounts, 

entries  may  be  vouched  or  verified  even  though  specific  vouchers, 
so  called,  are  not  available. 


SINGLE  AND  DOUBLE-ENTRY 
For  example,  the  following  is  illustrative: 


13 


d.  Minute  book 

e.  See  cash  payments  below 


e.  Cash  receipts 

f.  Bills  of  lading 

g.  Etc. 


c.  Credit  memos 

d.  Etc. 


1.  Purchases 

a.  Copies  of  orders 

b.  Receiving  clerk's  records 

c.  Checked  invoices 

2.  Sales 

a.  Customers'  orders 

b.  Shipping  clerk's  records 

c.  Copies  of  invoices 

d.  Customers'  accounts 

3.  Returned  Purchases 

a.  Stock  records 

b.  Shipment  records 

4.  Returned  Sales 

a.  Copies  of  memos  and  invoices  covering  original  charge 

b.  Vouchers  covering  cash  refunds 

c.  Customers'  statements  of  settlement 

d.  Etc. 

5.  Cash  Receipts 

a.  Bank  pass  book 

b.  Copies  of  deposit  slips  properly  bank  stamped 

c.  Receipt  book  stubs 

d.  Etc. 

6.  Cash  Payments 

a.  Receipts 

b.  Cancelled  checks 

c.  Pay  rolls 

7.  Journal  Entries 

a.  Journal  vouchers,  properly  approved 

b.  Correspondence 

c.  Minute  book 

d.  Approval  signature  of  proper  official  against  entry 

e.  Etc. 

Voucher  System. — The  apparent  predominant  use  of  the 
Voucher  System  seems  sufficient  reason  for  a  summary  discussion 
thereof  at  this  point.  This  system  purports  to  treat  creditors' 
accounts  so  that  the  necessity  for  keeping  the  individual  accounts 
in  a  Ledger  is  eliminated.  All  invoices  and  expense  bills  are 
attached  to  what  are  designated  as  "Voucher  Jackets"  after  the 
items  thereon  described  have  been  checked  out  properly  as  being 
in  order.  These  voucher  jackets  are  numbered  consecutively  and 
set  out  the  following  specific  information: 


d.  Petty  cash  vouchers 

e.  See  Purchases  above 

f.  Etc. 


14 


ADVANCED  ACCOUNTING 


1.  Name  and  address  of  creditor. 

2.  Items  received. 

3.  Account  or  accounts  to  be  charged  either  by  name  or  by 
number.  This  seems  unnecessary  in  a  small  concern  where 
one  person  either  makes  or  superintends  the  making  and 
entering  of  vouchers.  The  distribution  well  may  be  made 
only  upon  the  Voucher  Record. 

As  soon  as  a  voucher  has  been  prepared,  and  the  miscellancious 
papers  relative  thereto  attached,  it  is  entered  upon  a  Vouc^her 
Record  or  Register  and  at  least  the  following  information  set 
down : 

1.  Voucher  number.  Vouchers  are  numbered  consecutively  as 
entered. 

2.  Date. 

3.  Creditor's  name  and  address. 

4.  Total  amount  credited  to  either  Vouchers  Payable  or  Ac- 
counts Payable. 

5.  Distribution  of  the  charges  (debits)  to  the  usual  accounts 
for  which  separate  columns  have  been  provided,  and  to  a 
Sundry  column  for  unusual  items  which  is  divided  to  show 
both  the  name  or  number  of  the  unusual  account  and  the 
amount. 

When  a  voucher  is  paid,  the  payment  thereof  is  made  through 
the  Cash  Book  in  the  usual  way  except  that  the  charges  is 
against  the  Vouchers  or  Accounts  Payable  account  rather  than 
to  separate  creditors'  accounts.  Next,  such  payment  is  indi- 
cated upon  the  Voucher  Register  so  that  one  may  ascertain 
therefrom  what  vouchers  are  still  outstanding  unpaid,  the  total 
of  the  unpaid  vouchers  thereon  agreeing  with  the  balance  of  the 
Vouchers  Payable  account  upon  the  General  Ledger  after  the 
latter  has  been  posted  completely. 

Formerly,  when  a  voucher  was  paid,  it  was  current  practice  to 
send  out  the  voucher  with  the  check,  so  that  the  former  would 
be  signed,  after  which  it  was  to  be  returned.  However,  creditors 
were  not  usually  sufficiently  efficient  or  courteous  in  the  matter 
of  returning  a  voucher,  so  that  this  system  proved  to  be  de- 
cidedly at  fault;  it  was  necessary  to  rely  to  a  considerable  ex- 
tent upon  duplicate  copies  of  these  vouchers  to  operate  the  sys- 


SINGLE  AND  DOUBLE-ENTRY 


15 


tem.  Because  of  this,  the  use  of  the  voucher  check  has  proved 
of  great  value.  However,  one  would  be  in  error  to  assume  that 
the  voucher  check  necessarily  is  an  outgrowth  of  the  voucher 
system;  the  voucher  check  is  of  great  value  in  connection  there- 
with but  may  be  used  to  advantage  even  where  no  voucher  sys- 
tem is  in  operation.  A  voucher  check  may  be  no  different  from 
an  ordinary  check  beyond  the  fact  that  provision  is  made  thereon 
for  indicating  for  what  it  has  been  issued  in  payment.  Its  use 
combines  two  advantages: 

1.  That  of  having  evidence  a  certain  creditor  was  paid. 

2.  That  of  having  a  creditor's  signature  (the  indorsement) 
as  evidence  that  the  payment  covered  certain  specific  in- 
voices or  bills. 

Voucher  checks  may  carry  either  one  or  two  numbers: 

1.  One  number.  In  this  case,  the  number  thereon  would 
agree  with  the  voucher.  But  since  vouchers,  usually,  never 
are  paid  in  the  order  of  their  entry  upon  the  Voucher 
Register,  the  voucher  checks  cannot  be  entered  upon  the 
Cash  Book  in  consecutive  order;  this  is  a  disadvantage. 

2.  Two  numbers.  When  a  voucher  check  carries  two  numbers, 
the  first  one  would  be  the  voucher  number  and  the  second 
the  check  or  treasurer's  number.  Consecutive  entry  upon 
the  Cash  Book  is  possible  by  this  means  and  the  entry  upon 
the  Voucher  Register  relating  thereto  easily  is  traceable;  in 
fact,  this  double  numbering  permits  of  a  ready  cross-index 
between  the  Voucher  Register  and  the  Cash  Book. 

The  advantages  and  disadvantages  of  the  voucher  system  may 
be  summarized  as  under: 

1.  Advantages: 

a.  Labor  is  saved  by  elimination  of  the  Creditors'  Ledger. 

b.  All  purchases  are  analyzed  in  detail. 

c.  All  liabilities  are  booked  immediately. 

d.  Responsibility   is    localized   because   the   authority    for 
auditing,  entry,  and  payment  of  items  is  set  out. 

e.  All  payments  of  cash  are  evidenced  by  a  receipted  bill. 

f.  An  audit  is  expedited. 

2.  Disadvantages: 

a.  The  partial  payment  of  bills  and  notes  payable  tends  to 
break  down  the  system. 


16 


ADVANCED  ACCOUNTING 


b.  Returns  and  allowances  require  more  than  usual  hand- 
ling to  take  up  properly. 

c.  The  volume  of  business  with  important  creditors  ib  not 
summarized  for  reference  purposes. 

d.  In  a  business  of  any  size,  the  added  activities  necessary 
relative  to  filing,  recording,  and  O.  K.'ing  vouchers  is 
decidedly  expensive. 

e.  Certain  information  of  a  private  nature  may  come  into 

unscrupulous  hands  because  of  the  availability  of  the 

documents  that  are  attached  to  the  voucher  jackets. 

No  comment  upon  these  advantages  and  disadvantages  will 
be  made  herein. 

Confusion  sometimes  results  on  the  part  of  the  student  in  at- 
tempting to  comprehend  the  difference  between  certain  terms 
used  to  designate  the  various  stages  relative  to  a  creditor's  ac- 
count. In  an  attempt  to  clear  up  this  matter,  the  followmg  is 
offered  for  illustration: 

1.  Usually  there  is  no  difference  between  the  terms  Accounts 
Payable  and  Vouchers  Payable;  as  between  the  two,  the 
latter  is  preferable  in  connection  with  the  voucher  system. 

2.  At  times  one  encounters  the  terms  Unaudited  Vouchers  and 
Audited  Vouchers  upon  the  same  set  of  records.  The  first 
represents  creditors'  claims  for  payment  that  have  not 
passed  through  the  routine  of  the  internal  audit  procedure ; 
the  latter  represent  such  claims  that  have  passed  through 
and  await  payment.  The  accounts  will  be  arranged  to 
permit  of  proper  transfer,  as: 

A — Dr.   Goods 

Cr.  Unaudited  Vouchers 
B — Dr.  Unaudited  Vouchers 

Cr.   Audited  Vouchers 

3.  Another  possibility  sometimes  encountered  is  as  per  (2) 
above,  plus  the  use  of  the  term,  say,  Items  in  Transit. 
The  reason  therefor,  is  merely  to  have  the  books  of  ac(!ount 
reflect  all  liabilities  as  soon  as  incurred,  as: 

a.  Dr.  Goods  in  Transit 
Cr.  Items  in  Transit 

To  record  the  liability  when  an  order  has  been 
placed  and  accepted. 


SINGLE  AND  DOUBLE-ENTRY 


17 


b.  Dr.  Goods 

Cr.  Goods  in  Transit 

To  record  receipt  of  all  or  part  of  above  order. 

b.  1.  Dr.  Items  in  Transit. 

Cr.  Unaudited  Vouchers 

To  book  invoices  received. 

c.  Dr.  Unaudited  Vouchers 

Cr.  Audited  Vouchers 

To  record  vouchers  audited  and  ready  for  pay- 
ment. 

Trial  Balance.— Briefly,  a  Trial  Balance  is  a  list  or  table  of 
Ledger  balances,  showing  either  debit  and  credit  totals  of  each 
account  or  the  debit  or  credit  balance  of  each  account  drawn  as 
at  the  end  of  a  business  day  to  prove  the  mathematical  accuracy 
or  equilibrium  of  the  Ledger.  By  itself,  a  Trial  Balance  should 
not  be  taken  as  proof  of  the  correctness  of  the  Ledger  since  it  is 
possible,  where  errors  offset  each  other,  to  secure  a  Trial  Bal- 
ance from  a  Ledger  in  which  every  entry  is  in  error.  How- 
ever, if  a  Trial  Balance  does  not  prove,  it  is  proof  positive 
that  the  Ledger  is  incorrect,  but  when  it  does  prove,  the  cor- 
rectness of  Ledger  postings  is  inferred. 

The  usual  Trial  Balance  is  drawn  prior  to  commencing  the 
process  of  closing;  such  a  one  contains  both  real  and  nominal 
accounts.  Again,  a  Trial  Balance  is  often  prepared  after  the 
closing  process  is  completed  to  make  certain  the  Ledger  is  in 
balance  prior  to  entering  therein  the  transactions  of  the  subse- 
quent period.  Such  a  Trial  Balance  contains  only  real  accounts 
and  may  be  considered  as  an  unclassified  Balance  Sheet. 

After  a  Trial  Balance  is  found  to  be  in  balance,  it  properly 
may  be  called  Schedule  of  Ledger  Balances. 

Blocking  the  Ledger.— It  does  not  seem  advisable  to  use  the 
ordinary  methods  advocated  for  locating  an  error  in  a  Trial 
Balance  since  most  of  them  (being  more  or  less  a  matter  of  guess 
work),  result  in  a  waste  of  time.  The  analytical  method  of 
making  an  independent  posting  seems  to  be  the  only  satis- 
factory method  of  locating  an  error  after  a  detailed  reversed 
checking  has  failed  in  finding  the  amount ;  this  method  is  used 
by  many  auditors  when  making  an  ordinary  audit,  and  is  known 
as  ''blocking  the  ledger." 


18 


ADVANCED  ACCOUNTING 


Assuming  the  bookkeeper  has  been  accurate  in  entering  his 
foho  numbers,  one  of  these  methods  proceeds  about  as  foHows- 
The  Ledger  is  divided  into  blocks  of  fifty  or  a  hundred  pages 
each,  as  desired.  Upon  a  sheet  of  analysis  paper,  postings  are 
made  from  the  records  of  original  entry  to  the  columns  of  the 
analysis  sheet  by  blocks,  the  postings  from  each  book  of  original 
entry  being  kept  separate  from  the  others.  For  example,  the 
Cash  Book,  would  be  posted,  by  debits  and  credits,  to  the  block 
columns,  the  latter  then  added  up,  and  the  totals  compared  with 
the  Cash  Book  totals  corresponding  thereto. 

By  this  process,  the  footings  on  the  records  of  original  entry 
are  proved  out;  and  the  balances  of  each  block  are  found  as 
follows: 

1.  Secure  original  net  balance  of  a  block. 

2.  Add  or  deduct  therefrom  the  debits  and  credits  of  such 
block  and  compare  with  the  net  total  of  the  balances  at 
the  end  of  the  reviewed  period. 

3.  Eliminate  each  block  that  proves  out.  Then  recheck  in 
detail  the  work  relating  to  each  block  that  does  not  prove 
out.  Even  though  the  above  method  is  a  great  consumer 
of  time,  the  error  eventually  will  be  located ;  therefore  it 
is  worth  while.  ' 

Articulation  Statement :  Abstracting  AccountB.— An  artic- 
culation  statement,  as  to  meaning,  may  convey  more  than  one 
idea  to  a  person's  mind;  but  it  would  seem  that  the  only  meaning 
of  practical  worth  such  a  statement  should  have,  would  be  to 
consider  it  as  providing  a  convenient  means  for  classifying  the 
entries  for  an  elapsed  fiscal  period  according  to  the  books  of 
original  entry.  Auditors  often  use  such  a  statement  without 
recognizing  it  by  the  title  herein  suggested,  its  use  arising  in 
connection  with  the  process  known  as  ''abstracting  accounts." 
An  auditor  often  will  abstract  a  set  of  accounts  upon  working 
sheets  rather  than  check  out  a  General  Ledger  against  a  Trial 
Balance  either  prepared  by  the  bookkeeper  or  by  himself.  Again, 
the  method  is  useful  to  locate  the  error  when  a  (Jeneral  Ledger 
is  out  of  balance  since,  as  the  it^ms  are  posted  to  the  sheets 
according  to  account  names,  posting  errors  will  be  detected. 
Under  this  abstracting  process,  analysis  paper  is  used  that  has 


SINGLE  AND  DOUBLE-ENTRY 


19 


plenty  of  columnar  subdivisions.  The  General  Ledger  accounts 
are  entered  by  name  at  the  left  of  these  sheets  one  under  the 
other,  at  intervals  sufficiently  separated  one  from  the  other  to 
permit  of  the  inclusion  of  all  items  thereunder  by  postings. 
Next,  to  the  right,  the  columns  are  laid  out  in  pairs,  debit  and 
credit,  one  pair  for  each  record  of  original  entry.  From  the 
books  of  original  entry,  all  items  will  be  posted  to  these  sheet 
accounts,  only  the  totals  of  special  columns  and  books  being  used 
The  result  secured  by  this  process,  is  a  skeleton  General  Ledger, 
with  Accounts  Receivable  and  Accounts  Payable  controlling 
accounts. 

On  a  second  sheet  of  analysis  paper,  a  working  Trial  Balance 
would  be  prepared.  The  General  Ledger  balances  as  of  the 
beginning  of  the  period  would  be  entered  in  the  first  two  debit 
and  credit  columns  at  the  left;  then  in  the  next  pair  of  columns 
the  totals  of  the  debits  and  credits  of  each  account  from  the 
first  sheet  are  entered  on  the  respective  lines  and,  finally,  in  the 
third  or  last  pair  of  columns  the  resultant  balance  of  each 
account  would  be  entered.  These  final  figures  represent  the 
General  Ledger  Trial  Balance  at  the  end  of  the  period,  which 
is  to  be  checked  out  against  the  actual  Ledger  balances. 

The  abstracting  process  commences  with  the  Cash  Book,  all 
items  being  posted  therefrom  to  the  sheets,  including  the  total 
receipts  and  disbursements.  The  total  debits  and  credits  then 
are  summarized;  if  the  summary  balances,  the  Cash  Book  re- 
quires  no  footing  except  as  to  the  columns  from  which  only 
totals  have  been  taken.  After  the  work  in  connection  with  the 
Cash  Book  has  been  completed,  the  other  Journals  are  taken 
up,  one  after  the  other.  And  after  the  ending  Trial  Balance 
has  been  proved,  as  found  in  the  third  pair  of  columns  upon  the 
second  set  of  sheets,  the  remaining  columns  may  be  used  for 
the  usual  working  sheet  closing  the  set  of  books. 

Financial  Statements.— Nothing  will  be  said  at  the  present 
time,  beyond  the  second  paragraph  below,  concerning  either: 

1.  The  Balance  Sheet,  or 

2.  The  Profit  and  Loss  Statement  since  a  considerable  portion 
of  the  later  work  revolves  around  a  discussion  of  each. 

The  accounts  shown  in  a  Balance  Sheet  are  valued  as  follows: 
1.  Capital  assets— at  cost  less  depreciation. 


.^ 


I 


I: 


It 


20 


ADVANCED  ACCOUNTING 


2.  Current  assets. 

a.  Working  assets— at  cost  or  market  whichever  is  lower. 

b.  Other  current  assets — at  estimated  cash  value. 

Each  of  the  above  statements  is  a  statement  of  opinion,  not 
one  of  fact: 

1.  Balance  Sheet.  The  value  of  no  asset,  other  than  Cash, 
can  be  ascertained  to  a  certainty.  Each  other  asset  is 
subject  to  contingencies  which  may  change  the  valuation 
given. 

2.  Statement  of  Profit  and  Loss.  Inventory  valuations,  the 
reserves  for  depreciation,  and  the  doubtful  accounts  receiv- 
able, as  to  amounts,  are  all  matters  of  opinion.  Therefore, 
the  net  profit  is  a  matter  of  opinion,  tempered  by  the 
experience  of  the  accountant. 

However,  the  opinion  of  a  qualified  accountant,  as  to  these 
statements,  will  be  sufficiently  accurate  to  the  end  that,  there- 
from, one  may  secure  a  reasonably  correct  idea  of  the  condition 
of  the  business  concerned. 

Types  of  Assets. — ^Assets  may  be  divided  into  a  number  of 
classes,  about  as  follows: 

1.  Current.  These  are  assets  which  are  presumed  to  be  readily 
convertible  into  cash  under  the  usual  routine  of  business. 
They  are  not  permanent  investments  but  are  intended  for 
sale, — in  their  present  condition  as  manufactured  product 
or  as  the  elements  from  which  manufac^tured  product  will 
be  made.  At  times,  these  assets  are  spoken  of  as  floating, 
active,  or  circulating. 

2.  Quick.  These  are  assets  of  the  current  group  exclusive  of 
securities, — ^those  readily  marketable  and  saleable,  and  notes 
and  accounts  given  by  or  due  from  officers,  stockholders, 
and  employees;  also,  exclusive  of  deferred  charges.  At 
times,  these  assets  are  spoken  of  as  liquid. 

3.  Working  or  trading.  These  are  the  current  assets  of  inven- 
tories,— raw  material,  goods  in  process,  and  manufactured 
product;  and,  sometimes,  supplies. 

4.  Capital.  These  are  the  assets  of  a  business  that  are 
not  held  for  sale  purposes,  since  held  as  permanent  invest- 
ments to  enable  the  business  to  function  for  the  purposes  for 
which  organized.  They  may  be  spoken  of  as  fixed,  perma- 
nent, or  passive. 


SINGLE  AND  DOUBLE-ENTRY 


21 


5.  Deferred  charges  to  operation.  These  assets  represent  por- 
tions of  expense  items  paid  in  the  current  period  but  ap- 
plicable to  a  subsequent  period. 

6.  Accrued.  These  are  current  assets  which  accimiulate  grad- 
ually with  the  passage  of  time. 

7.  Contingent.  These  are  assets  in  what  might  be  called  an 
embryonic  stage,  becoming  full-fledged  assets  only  upon 
the  happening  of  some  event  which  at  present  is  more 
or  less  uncertain. 

8.  Wasting.  This  type  of  asset  loses  value  because  the  asset 
itself  is  used  up;  it  diminishes  or  shrinks  in  direct  propor- 
tion to: 

a.  Operations— Natural  resources  such  as  stumpage,  etc. 

b.  Lapse  of  time — Patent  or  leasehold. 

A  depreciating  asset  should  not  be  confused  with  a  wasting 
asset.  Of  course,  both  lose  value,  and  such  loss,  in  gen- 
eral, may  be  designated  as  depreciation,  but  the  former 
type  is  not  consumed,  or  does  not  shrink  in  size,  as  does 
the  latter. 

9.  Secret.  These  represent  asset  values  in  excess  of  the  book 
values  thereof. 

Types   of   Liabilities.— Liabilities  may   be   divided   into   a 
number  of  classes,  about  as  follows: 

1.  Current.  These  are  liabilities  which  must  be  paid  at  once 
or  which  will  mature  within  a  short  period  of  time  and 
which,  presumably,  are  to  be  paid  in  the  normal  course 
of  events. 

2.  Capital.  These  liabilities  need  not  be  paid  at  once  since 
they  will  not  mature  except  after  the  passage  of  a  long 
period  of  time.  They  are  of  a  permanent  character  and  do 
not  change  frequently  since  they  are  intended  to  furnish 
the  funds  for  investment  in  the  business.  They  may  be 
spoken  of  as  fixed. 

3.  Deferred  credits  to  income.  These  liabilities  represent  por- 
tions of  income  received  in  a  current  period  but  applicable 
to  a  subsequent  period. 

4.  Accrued.  These  are  current  liabilities  which  accumulate 
gradually  with  the  passage  of  time. 

5.  Contingent.    These  are  liabilities  in  what  might  be  called 


22 


ADVANCED  ACCOUNTINO 


an  embryonic  stage,  becoming  full-fledged  liabilities  only 
upon  the  happening  of  some  event  which  at  present  is  more 
or  less  uncertain. 

6.  Funded.  These  are  liabilities  the  payment  of  which  has 
been  provided  for  definitely;  usually,  they  are  secured  by 
a  mortgage. 

7.  Bonded.  These  are  liabilities  which  are  evidenced  by  a 
bond  issue.  Such  liabilities  may  be  funded  or  not  funded, 
secured  or  not  secured. 

Two  Bases  of  Accounting.— There  are  two  bases  of  account- 
ing, each  of  which  is  described  briefly  below: 

1.  Cash  basis.  Hereunder,  income  and  expenses  are  recorded 
only  when  they  affect  either 

a.  Cash  or 

b.  Personal  accounts. 

2.  Accrual  basis.  Hereunder,  all  income  and  expenses  are 
booked  as  incurred,  rather  than  when  received  or  paid  in 
cash.  Particularly,  at  the  end  of  each  fiscal  period,  care 
must  be  observed  to  make  certain  that  all  accruals  have 
been  placed  upon  the  books.  In  adjusting  the  accruals  at 
the  end  of  the  year,  the  procedure  resolves  itself  into  two 
steps : 

a.  Reverse  or  write  back  the  accrual  as  of  the  preceding 
January  1. 

b.  Record  the  accrual  as  of  December  31. 

Deferred  and  Contingent  Items.— It  usually  is  worth  while 
to  distinguish  between  accrued  and  deferred  items.  Deferred 
items  are  of  two  classes: 

1.  Deferred  charges.  In  turn,  deferred  charges  are  of  two 
kinds: 

a.  Expense  items  which,  in  part,  benefit  future  periods.  The 
portion  benefiting  a  subsequent  period  is  a  deferred 
charge. 

b.  Expense  items  which,  although  they  do  not  benefit  future 

periods  are  deferred  to  be  written  off  gradually  thereover. 

Again,  deferred  charges  may  be  separated  into  a  further  two- 
way  division: 

a.  Those  which  have  a  realizable  value,  as  prepaid  insurance. 


SINGLE  AND  DOUBLE-ENTRY 


23 


b.  Those  which  have  no  realizable  value,  as  organization 
expense. 

This  distinction  may  be  important  in  setting  up  what  is 

known  as  a  Statement  of  Fund  Application,  which  will 

be  discussed  in  a  later  chapter. 

2.  Deferred  credits.     These  represent  income  items  received 

in  a  current  period  which   are  applicable  to   subsequent 

periods.     Therefore,  the  amount  so  applicable  to  future 

periods  must  be  considered,  as  of  the  present  moment,  as  a 

liability. 

Contingent  items  are  of  two  classes: 

1.  Contingent  assets.     Ordinarily,  these  are  not  shown  upon 
the  books. 

a.  Not  shown  upon  the  books. 

i.  Pending  damage  suit  against  another, 
ii.  Conditional  bequest  in  a  will. 

b.  Shown  upon  the  books. 

i.  A  note  receivable  which  has  been  endorsed  and 
discounted.    This,  also,  is  a  contingent  liability. 

2.  Contingent  liabilities.  Ordinarily,  these  are  not  shown  upon 
the  books. 

a.  Not  shown  upon  the  books. 

i.  Pending  damage  suit  against  our  firm  or  company, 
ii.  Surety  bonds, 
iii.  Guarantees. 

b.  Shown  upon  the  books. 

i.  Notes  receivable  discounted. 

Capital  Versus  Deficit— Capital  has  two  meanings  dependent 
upon  the  viewpoint: 

1.  Economic.    The  total  amount  of  wealth  invested  in  a  busi- 
ness,— all  assets  of  a  business. 

2.  Accounting.    The  excess  of  the  assets  of  a  business  over  its 
liabilities, — the  proprietor's  net  equity. 

Working  capital  is  the  excess  of  net  current  assets  over  current 
liabilities. 

Deficit  may  be  considered  the  exact  opposite  of  accounting 
capital,— the  excess  of  liabilities  over  assets. 

Income— Revenue— Earnings.— Income  may  be  defined  as 
the  remuneration  or  gain  which  results  from  the  use  of  property 


24 


ADVANCED  ACCOUNTING 


and  labor,  and  the  results  of  business.    Income  may  be  doubly 
classified: 

1.  First  classification: 
a.'  Rent. 

b.  Wages. 

c.  Interest. 

d.  Profits. 

2.  Second  classification: 

a.  Operating. 

b.  Non-operating. 

Revenue,  as  a  term,  has  a  slightly  different  meaning  from 
income,  even  though,  at  times,  the  two  terms  are  used  inter- 
changeably. Non-trading  concerns  are  apt  to  use  the  term  rev- 
enue in  preference  to  that  of  income. 

Earnings  represent  income  that  has  been  secured  from  the 
sale  of  personal  services.  A  public  service  corporation  and  a 
professional  man  would  use  this  term  in  preference  to  that  of 
revenue  or  income. 

Profit:  Gross— Net— Operation— Capital.— Profit  may  be 
defined,  from  the  accounting  viewpoint,  as  the  surplus  of  in- 
come remaining  at  the  end  of  a  period  after  all  costs  and  ex- 
penses have  been  taken  into  consideration.  From  this  view- 
point, accounting  profit  and  economic  profit  are  dissimilar: 

1.  Accounting  viewpoint: 

a.  Net  income  and  net  profit  are  assumed  to  be  the  same. 

2.  Economic  viewpoint: 

a.  Net  income  would  be  classified  as: 

i.  Rent, 
ii.  Wages, 
iii.  Interest, 
iv.  Profit. 

Gross  profit  represents  the  excess  of  net  sales  price  over  the 
cost  of  goods  sold.  Net  profit  from  operation  represents  the 
excess  of  gross  profit  over  the  total  of  the  selling  and  administra- 
tive expenses.  Net  profit  for  an  elapsed  period  represents  the 
excess  of  the  net  profit  from  operation  over  the  net  deductions 
from  income  (financial  expenses  less  financial  income). 

A  capital  profit  results  from  a  change  in  the  value  of  certain 


SINGLE  AND  DOUBLE-ENTRY  25 

of  the  capital  assets.  It  should  not  be  shown  upon  the  books 
unless  the  assets  concerned  have  been  disposed  of  in  some  way. 
Losses,  qualified  by  prefixes  as  above  set  out,  may  be  consid- 
ered the  opposite  of  profits  thus  qualified.  Basically,  no  profit 
should  be  taken  unless  a  just  cause  for  legal  action  has  arisen. 

Receipts— Disbursements— Expenses— Expenditures.— Re- 
ceipts,  as  a  term,  refers  to  cash  or  other  assets  received  during 
the  course  of  business,  regardless  of  whether  they  are  concerned 
with  capital  or  revenue.  Ordinarily,  however,  when  one  speaks 
of  ^'receipts,"  he  refers  entirely  to  cash.  Receipts  may  be 
divided  into  two  classes: 

1.  Revenue  receipts.  Cash  or  other  assets  received  on  account 
of  the  regular  operation  of  a  business. 

2.  Capital  receipts.  Cash  or  other  assets  received  on  account 
of  the  sale  of  a  fixed  asset,  of  capital  stock,  or  of  a  bond 
issue. 

Where  receipts  is  used  in  connection  with  disbursements,  the 
two  refer  to  cash  receipts  and  cash  disbursements,  regardless  of 
purpose. 

A  revenue  expense  is  an  operation  expense,  one  the  result  of 
an  attempt  to  make  a  profit  from  business  operation.  A  capital 
expense  is  a  non-operation  expense,  a  financial  expense  made 
necessary  in  providing  the  capital  needs  of  a  concern.  A  rev- 
enue expenditure  may  be  considered  as  a  revenue  expense  except 
as  concerns  the  deferred  portion  thereof  which  will  be  shown 
upon  a  Balance  Sheet  as  a  deferred  charge  to  operation.  A 
capital  expenditure  is  one  made  on  account  of  an  improve- 
ment, or  of  an  addition,  to  the  more  or  less  permanent  plant  of 
an  enterprise. 

A  fixed  charge  is  an  expense  to  be  met  periodically  without 
regard  to  the  amount  of  business  done,  as  bond  interest.  It  is 
more  or  less  fixed  in  its  recurring  amount. 


CHAPTER  II 
SPECIFIC  REAL  AND  NOMINAL  ACCOUNTS 

Introduction. — It  is  the  purpose  of  this  chapter  to  review,  in 
more  or  less  summary  form,  many  of  the  points  usually  dis- 
cussed in  first-year  accounting  as  indicated  by  the  present 
chapter  title.  The  background  afforded  by  the  review  of  Chap«. 
I,  II,  and  III  should  prove  of  exceptional  worth  in  bridging  the 
gap  so  apt  to  exist  between  the  work  of  the  first  and  second 
years  in  a  course  in  accounting. 

Cash  and  Cash  Records. — If  Cash  be  treated  properly,  all 
moneys  received  should  be  deposited  in  bank;  and  all  moneys 
paid  out  should  be  by  check,  except  small  payments  which  are 
handled  through  the  Petty  Cash  fund  operated,  preferably,  upon 
the  imprest  basis. 

As  concerns  Cash  receipts,  the  following  points  appear  to  be 
of  considerable  importance: 

1.  All  incoming  remittances  should  be  listed  upon  a  Daily 
Blotter  by  some  person  other  than  the  cashier  or  book- 
keeper, and  prior  to  turning  these  remittances  over  to  the 
cashier  for  entry. 

2.  The  bank  deposit  should  be  prepared,  say,  daily,  beginning 
at  a  specified  moment  of  time  which  will  allow  sufficiently 
for  the  deposit  to  be  made  before  the  depositary  closes  for 
the  day.  When  the  deposit  is  in  order,  the  person  men- 
tioned in  (1)  above  should  be  on  hand,  enter  upon  his  daily 
blotter  the  cash  receipts  for  the  day  taken  in  over  the 
counter,  or  shown  on  the  cash  register,  secure  a  total  of  the 
two  amounts  and  compare  such  total  with  the  deposit  slip. 
Again,  upon  the  return  of  the  Pass  Book,  this  individual 
should  scrutinize  the  entry  therein,  comparing  its  amount 
with  the  total  referred  to  above. 

3.  All  checks  making  up  part  of  the  cash  balance  on  hand 

26 


SPECIFIC  REAL  AND  NOMINAL  ACCOUNTS 


2fl 


should  be  deposited  even  though  some  have  been  signed 
by  the  concern.  Sight  drafts  are  considered  as  checks. 
4.  If  the  cashier  and  the  bookkeeper  are  one  and  the  same 
person,  which  ought  not  to  be  the  case  where  possible  to 
separate  the  two  functions,  the  proprietor  must  exercise 
the  greatest  of  care  for  his  protection;  the  greatest  of 
care  will  be  defective  in  certain  respects.  At  least,  he 
can  require  to  have  turned  over  to  himself  duplicate  copies 
of  all  detailed  cash  records;  these  he  should  keep  under 
lock  and  key  until  audited. 

As  concerns  cash  payments,  the  lollowing  points  seem  im- 
portant : 

1.  Since  cancelled  checks,  by  themselves,  are  not  sufficient 
vouchers  covering  cash  disbursements,  all  cash  payments 
should  be  supported  by  vouchers  other  than  cancelled 
checks. 

2.  Missing  checks  always  must  be  accounted  for,  after  either 
the  Pass  Book  has  been  balanced  or  the  Bank  Statement 
received. 

3.  If  more  than  one  bank  account  is  necessary,  it  may  be 
advisable  to  carry  each  with  a  separate  depositary,  rather 
than  have  them  all  with  one  bank.  Likewise,  if  funds  are 
carried  in  more  than  one  bank,  a  separate  Check  Register 
for  each  such  bank  may  be  desirable. 

4.  Checks  should  not  be  drawn  until  they  are  to  be  delivered. 
The  habit  of  drawing  checks  and  holding  them  seems  to 
be  bad  practice.  Such  checks,  naturally,  do  not  affect  the 
accounts. 

In  reconciling  the  Cash  balance  on  hand,  per  Cash  Book,  with 
the  balance  reported  by  the  bank,  one  should  work  from  the 
reported  bank  balance,  after  this  .has  been  checked  up  and 
appears  in  order,  backward  to  the  Cash  Book  balance  since  the 
latter,  if  correct,  must  appear  upon  the  Balance  Sheet  when  the 
latter  is  prepared.  If  the  bank  balance  as  at  a  particular 
moment  of  time  should  be  different  from  the  Cash  Book  balance, 
the  reconciliation  may  assume  the  following  form  frequently 
used  in  auditing: 

1.  We  debit,  bank  does  not  credit. 

2.  We  credit,  bank  does  not  debit. 


28 


ADVANCED  ACCOUNTING 


3.  Bank  debits,  we  do  not  credit. 

4.  Bank  credits,  we  do  not  debit. 

5.  Bank  balance  plus  (1)  and  (3)  should  be  equal  to  Cash 
Book  balance  plus  (2)  and  (4). 

A  cash  account  should  be  carried  upon  the  General  Ledger; 
in  fact,  all  accounts  necessary  to  the  securement  of  a  Trial 
Balance  of  the  General  Ledger  should  be  found  thereon.  A  Cash 
Short  and  Over  account  should  hold  the  daily  overage  or  short- 
age ascertained  when  the  daily  balance  is  checked  against  the 
Cash  Book.  The  net  balance  thereof  may  be  handled  in  one  of 
two  ways: 

L  If  the  cashier  is  held  accountable  for  any  shortage  to  the 
end  that  he  must  make  it  good,  the  balance  represents  a 
claim  against  him.     If  an  overage,  he  has  that  much  on 
hand  to  apply  against  a  future  shortage. 
2.  If  the  cashier  is  not  required  to  make  good  a  small  short- 
age, the  Cash  Over  and  Short  account,  ultimately,  will  be 
closed  out  into  Profit  and  Loss. 
Payments  of  actual  cash  should  be  kept  as  few  in  number, 
and  as  small  in  amount,  as  possible.    In  this  connection,  the 
Petty  Cash  fund  is  used.     This  fund  may  be  one  of  two  types: 

1.  Constant  balance.  This  is  said  to  be  operated  on  the 
imprest  basis. 

2.  Fluctuating  balance.  This  type  of  fund  is  not  to  be  pre- 
ferred to  (1)  above. 

Cash  Books  may  be  divided  into  four  types; 

1.  General  Cash  Records.  In  these,  all  cash  transactions  are 
booked,  except  those  pertaining  to  the  Petty  Cash  funds. 
There  may  be  one  record  in  which  both  receipts  and  dis- 
bursements are  carried,  or  a  number  of  such  records. 
Again,  the  receipts  may  be  recorded  in  one  or  more  Receipt 
Registers  which  are  bound  separately  from  the  record  or 
records  holding  Cash  disbursements,— the  Check  Register 
or  Registers. 

2.  Petty  Cash  Records.  Herein  are  recorded  the  expenditure 
of  the  various  Petty  Cash  funds,  one  book  for  each  fund. 

3.  Private  Cash  Book.  This  record  is  used  in  connection  with 
the  Private  Ledger  and  Private  Journal. 


SPECIFIC  REAL  AND  NOMINAL  ACCOUNTS 


29 


4.  Casn  Journal.     Herein  are  recorded  both  Cash  and  non- 
Cash  items.    It  is  a  columnar  record  which  is  supposed  to 
replace  all  the  usual  records  of  original  entry.    It  even  may 
be  used  so  as  to  replace  the  use  of  a  General  Ledger;  in 
this  case,  it  might  be  titled  Cash  Book — Journal — Ledger. 
Statement   of   Cash   Receipts   and    Disbursements.— This 
statement  may  be  considered  as  a  transcript  of  the  Cash  Book 
for  a  specified  period  of  time.    It  should  be  constructed  along 
the  following  lines: 

1.  Balance — Beginning  of  period. 

2.  Receipts — ^properly  classified. 

3.  Total  cash  available, — sum  of  (1)  and  (2). 

4.  Disbursements — ^properly  classified. 

5.  Balance — end  of  period, — (3)  less  (4). 

This  statement  is  not,  generally,  the  same  as  a  Statement  of 
Income  and  Expenses: 

1.  The  former  statement  represents  merely  a  rearrangement  of 
the  information  shown  in  the  Cash  Book. 

2.  The  latter  statement  includes  all  income  and  expense  items, 
whether  received  or  paid  in  cash  or  not.  Only  in  an  activ- 
ity similar,  say  to  that  of  a  club  would  it  be  possible  to 
have  both  statements  include  the  same  items,  and  thus 
they  would  both  hold  the  information  for  a  Statement  of 
Receipts  and  Disbursements: 

a.  No  cash  balance  on  hand  at  the  beginning  of  the  period 
as  where,  perhaps,  it  is  the  first  year  of  existence. 

b.  No  accruals  of  any  kind. 

Notes   Versus   Bills. — These  two  terms,  oft^n  used   inter- 
changeably, really  do  not  represent  the  same  thing: 

1.  Note.  A  promissory  note, — unconditional  promise  to  pay 
a  specified  siun  of  money  upon  a  fixed  or  determinable 
future  date. 

2.  Bill: 

a.  A  draft  or  bill  of  exchange, — a  written  order  by  one 
person  upon  a  second  person  to  pay  a  third  person  the 
amount  of  money  therein  set  out.  Example:  Trade  ac- 
ceptances. 

b.  Invoice.    An  invoice  often  is  referred  to  as  a  "bill." 

In  general,  however,  it  seems  correct  to  use  one  title  as 
covering  both,— Notes  Receivable,  or  Notes  Payable. 


30 


ADVANCED  ACCOUNTING 


Notes  Receivable. — A  note  receivable  is  assumed  to  be 
preferable  to  an  open  account  with  a  debtor  for  three  reasons: 

1.  It  acknowledges  that  the  amount  of  the  debt  is  correct. 

2.  A  dishonored  note  may  wreck  one's  credit  rating,  whereas 
an  overdue  open  account  may  not  be  considered  of  much 
discredit  to  the  payer. 

3.  The  date  upon  which  the  debt  is  payable  is  specified, 
whereas  the  due  date  of  an  open  account  may  not  be  fixed 
except  by  custom. 

In  this  case,  it  is  usual  to  have  the  collateral  in  an  amount 
equal  to  from  25  per  cent  to  50  per  cent  of  the  face  value  of  tlie 
note  secured  thereunder. 

Dishonored  Notes  Receivable. — ^When  a  note  has  been  dis*- 
honored,  practice  dictates  that  the  note  should  be  written  back 
into  the  account  receivable  that  was  credited  originally  when 
the  note  was  received.  By  so  doing,  the  account  with  the  debtor 
will  contain  a  record  of  the  dishonor  which  will  be  of  great  use 
in  granting  such  debtor  future  credit.  This  writing  back,  how- 
ever, does  not  change  the  status  of  the  note  claim  back  again  to 
that  of  an  account  claim;  the  holder  may  sue  either  upon  the 
note  or  upon  the  account. 

When  a  number  of  notes  are  taken,  it  becomes  important 
not  to  lose  sight  of  the  fact  that  the  credit  made  to  a  customer's 
account  does  not  necessarily  represent  a  complete  settlement  to 
that  extent.  In  such  event,  the  practice  is  followed  more  or  less 
of  having  the  Customer's  Ledger  ruled  with  two  debit  and  two 
credit  columns.  The  inside  columns  would  be  used  for  the 
note  transactions  and  the  outside  columns  for  the  regular  open 
account  transactions;  only  the  latter  would  hold  amounts  affect- 
ing the  Trial  Balance. 

Notes  Receivable  Discounted. — Since  a  discounted  note 
receivable  is  a  contingent  liability,  it  is  in  error  to  credit  the 
Notes  Receivable  account  when  a  note  is  discounted;  the  credit 
should  be  made  to  the  account  of  Notes  Receivable  Discounted, 
this  latter  account  being  proportionately  cancelled  against  the 
Notes  Receivable  account  when  notice  has  been  received  that 
payment  of  a  note  has  been  honored.  The  same  procedure  i« 
possible  when  a  note  receivable  has  been  given  to  a  creditor, 
since  no  essential  difference  exists  between  giving  a  note  receiv- 
able to  a  creditor  and  discoimting  it  at  the  bank. 


I 


SPECIFIC  REAL  AND  NOMINAL  ACCOUNTS 


31 


On  the  Balance  Sheet,  the  Notes  Receivable  Discounted  ac- 
count may  be  handled  in  either  of  the  following  ways  as  under: 

1.  Deduct  the  balance  therein  from  the  balance  of  the  Notes 
Receivable  account. 

2.  Show  on  the  asset  side  of  the  statement  the  notes  in  two 
amounts, — ^those  on  hand  and  those  discounted, — and  set 
out  the  discounted  amount  on  the  liability  side. 

Loss  on  Notes  Receivable. — Provision  should  be  made 
periodically  for  possible  loss  on  uncollectible  notes  receivable. 
Such  provision  may  be  computed  in  either  one  of  the  two  fol- 
lowing ways: 

1.  Calculate  the  amount  to  be  provided  separately  upon  the 
note  item  alone.  This  seems  preferable  to  the  second  one 
below. 

2.  Total  the  notes  and  accounts  receivable,  and  compute  the 
estimated  provision  for  uncollectible  items  on  the  basis  of 
such  total.  This  means  that  the  Reserve  for  Uncollectible 
Accounts  covers  both  notes  and  accounts  receivable.  This 
second  possibility  does  not  appear  to  represent  good  ac- 
counting practice. 

Notes  Receivable  Register. — This  record  may  or  may  not  be 
considered  as  a  Journal, -^as  a  record  of  original  entry  from 
which  postings  are  made  to  the  Ledger  or  Ledgers. 

1.  When  not  considered  as  a  Journal.  Such  a  record  is  a  mere 
memorandum  book,  the  note  entries  being  made  upon  the 
General  Journal  and  being  posted  therefrom.  Naturally, 
where  a  large  number  of  notes  are  taken,  it  would  seem  that 
this  method  of  booking  is  not  conducive  to  time-saving  in 
that  two  operations  are  necessary,  whereas  one  would  suf- 
fice: 

a.  The  notes  must  each  be  recorded  in  the  memo  record. 

b.  The  notes  must  each  be  journalized  on  the  General  Jour- 
nal. 

2.  When  considered  as  a  Journal.  One  operation  is  sufficient 
hereimder.  Each  note  is  entered  upon  the  Register  and  the 
posting,  both  to  the  detail  and  control  accounts,  may  be 

made  immediately. 

The  same  idea  of  recording  would  be  followed  in  the  case  of 
notes  payable. 


'I 

ft' 

\  \ 


32 


ADVANCED  ACCOUNTING 


Interest  and  Discount  on  Notes  Receivable. — Before  con- 
cluding the  present  discussion  of  notes  receivable,  a  few  remarks 
concerning  interest  and  discount  on  notes  receivable  seem  in 
order.  Ordinarily,  a  note  receivable  should  be  booked  at  its  face 
value,  i.  e.,  without  considering  interest  from  the  day  it  is  dated 
to  the  date  of  maturity.  An  exception  to  this  treatment  is  found 
where  a  bank  adds  interest  to  the  basic  amount  of  the  note  so 
that  its  face  value  will  be  equal  to  the  total  amount  due  upon 
date  of  maturity ;  naturally,  when  the  bank  discounts  such  a  note 
it  will  calculate  interest  upon  the  whole  amount,  which  means 
that,  thereunder,  interest  is  calculated  upon  interest. 

Bank  discount  is  interest  deducted  in  advance,  chargeable  to 
a  prepaid  Interest  account,  or  to  an  account  earmarked  in  sucli 
a  way  that  the  charge  will  not  be  merged  in  the  account  carried 
with  Cash  Discount, — ^the  latter  representing  an  allowance  made 
for  paying  an  open  account  promptly. 

Since  bank  discount  is  interest  deducted  in  advance  from  the 
face  of  a  note,  the  bank  thereunder  giving  credit  merely  for 
the  net  amount  remaining,  the  fact  should  be  noticed  that,  by 
this  means,  the  borrower  receives  proceeds  in  an  amount  lesB 
than  the  whole  amount  of  the  note,  whereas,  he  pays  interest 
upon  the  whole  amount  of  the  note.  Because  of  this  fact,  the 
difference  arises  between  bank  discount  and  true  discount.  To 
calculate  the  latter,  divide  the  amount  of  the  face  of  the  note  by 
$1  plus  interest  on  this  $1  at  the  rate  specified,  for  the  time 
involved;  the  amount  thus  determined  represents  the  sum  the 
borrower  should  receive  upon  the  true  discount  basis.  Interest 
upon  such  sum  for  the  period  and  rate  specified,  represents  the 
amount  of  the  true  discount. 

Accounts  Receivable. — ^As  a  title,  this  term  should  not  be 
used  as  a  Ledger  account  heading  except,  perhaps,  in  connection 
with  the  controlling  account  over  the  Customer's  Ledger.  Prac- 
tice, at  least,  will  advocate  the  latter  use  of  the  term,  even 
though  the  caption  Customers'  Accounts  or  Trade  Debtors  would 
seem  preferable.  If  other  than  the  accounts  of  customers  be 
involved,  as  accounts  with  officers  and  employees,  these  other 
accounts  should  be  set  out  separately  by  kinds.  The  credit  bal- 
ances in  customers'  accounts  represent  liabilities  to  be  set  out 
upon  the  Balance  Sheet  under  an  appropriate  heading. 


SPECIFIC  REAL  AND  NOMINAL  ACCOUNTS 


33 


Regardless  of  what  one  may  encounter  in  practice,  when  only 
one  Ledger  is  used  for  holding  all  the  accounts  of  a  business, 
care  should  be  observed  in  sectionalizing  such  Ledger  to  the  end 
that  the  customer's  accounts  will  occupy  one  division  by  them- 
selves. By  this  means,  a  controlling  account  thereover  may  be 
carried  in  the  division  allotted  to  the  general  accounts.  The 
same  comments  apply  to  creditors'  accounts.  However,  the 
number  of  customers'  accounts  does  not  have  to  be  great  to 
justify  the  use  of  a  subsidiary  Ledger  therefor;  in  fact,  as  soon 
as  any  justification  exists  for  the  use  of  a  separate  Ledger,  the 
latter  should  be  secured.  Such  justification  would  seem  to  exist, 
even  when  the  number  of  accounts  is  small,  where  a  Ledger  rul- 
ing different  from  that  of  the  General  Ledger  is  desirable. 

In  the  use  of  a  separate  Ledger  for  customers'  accounts,  the 
account  arrangement  therein  may  depend  more  or  less  upon  ex- 
isting circumstances.  The  following  arrangements  are  illustra- 
tive: 

1.  In  the  order  in  which  the  accounts  are  opened.  In  connec- 
tion herewith  an  index  seems  necessary  even  though  the 
bookkeeper,  through  long  experience,  may  be  thoroughly 
familiar  with  the  location  of  various  accounts. 

2.  Alphabetically.  Such  arrangement  may  be  desirable  upon 
either  a  loose  leaf  or  card  Ledger. 

3.  By  geographical  location.  Give  each  state  a  particular 
section  of  the  Ledger,  and  arrange  the  towns  thereunder 
in  alphabetical  order;  customers  within  each  town,  likewise, 
should  be  arranged  in  alphabetical  order.  In  connection 
with  this  arrangement,  a  card  index,  or  an  index  of  some 
kind,  should  be  kept  by  customers'  names. 

4.  Etc. 

When  drawing  off  a  Trial  Balance  or  an  abstract  of  the  cus- 
tomers' accounts,  for  Trial  Balance  purposes,  it  would  seem  that 
the  most  satisfactory  method  to  follow  would  be  to  list  the 
amounts  in  three  columns: 

1.  Current — good. 

2.  Past  due — short  time  only. 

3.  Doubtful. 

Whether  or  not  an  account  actually  is  bad  depends  entirely 


34 


ADVANCED  ACCOUNTING 


upon  both  the  character  of  the  customer  and  of  the  business; 
no  general  rule  can  be  advanced  which  will  cover  all  cases. 

Bad  Debts :  Reserve  for  Bad  Debts. — Periodically,  provision 
must  be  made  for  customers'  accounts  which  app(;ar  to  be  doubt- 
ful of  collection.  To  this  end,  it  may  be  highly  desirable  to 
do  what  is  known  as  "aging  the  accounts," — preparing  a  list  of 
the  accounts  with  their  balances  and  then,  with  the  aid  of  some 
person  familiar  with  the  circumstances  of  each  case,  as  the  credit 
man,  analyze  the  balances  separating  them  into  good,  doubtful, 
and  bad.  The  bad  accounts  should  be  charged  against  the  R(;- 
serve  for  Bad  Debts,  and  the  reserve  then  should  be  increased 
sufficiently  to  offset  the  total  amount  of  the  doubtful  item^. 
Provision  for  losses  on  bad  debts  is  a  non-operating  expense, 
and  the  amount  of  the  reserve  should  be  considered  as  a  valua- 
tion item;  the  Reserve  for  Bad  Debts  does  not  seem  to  be  a 
surplus  reserve,  a  liability  reserve,  or  a  contingency  reserve. 

Doubtful  accounts  are  better  eliminated  from  the  regular  cus- 
tomers' Ledger  than  retained  thereon;  if  done,  they  would  be 
transferred  to  what  might  be  termed  a  Suspense  Ledger.  Lik(»- 
wise,  if  desired,  instead  of  writing  a  bad  debt  off  the  books, 
these  may  be  included  upon  this  Ledger  also,  and  the  individual 
accounts  placed  in  the  hands  of  attorneys  for  collection.  In 
either  event,  a  reserve  account  should  be  created  of  a  size  suffi- 
cient to  offset  the  inflated  asset  value  thereon.  If  the  doubtful 
accounts  are  carried  upon  the  regular  Ledger,  and  only  the  ac- 
counts in  the  hands  of  attorneys  are  carried  upon  the  Suspense 
Ledger,  the  size  of  the  offsetting  reserve  for  the  Suspense  Ledgt^r 
would  be  calculated  about  as  follows:  14  of  the  total  items  for 
the  current  year;  1/2  of  the  total  of  the  items  two  years  old;  34 
of  the  total  of  the  items  three  years  old;  all  those  four  years  old 
charged  off  completely.  However,  to  take  advantage  of  the 
Income  Tax  Law  provisions  permitting  bad  debts  to  be  con- 
sidered as  expenses,  the  bad  accounts  must  actually  be  writ- 
ten off. 

If  a  bad  account  which  has  been  written  off  in  one  period  ii 
collected  in  whole  or  part  in  a  subsequent  period,  it  would  seem 
correct  to  credit  the  Surplus  account  in  the  amount  of  the  collec- 
tion, rather  than  credit  the  Profit  and  Loss  account,  in  that, 
when  the  charge  was  made  originally,  the  Surplus  account  was 
affected. 


SPECIFIC  REAL  AND  NOMINAL   ACCOUNTS 


35 


1 


Average  Due  Date. — Without  discussing  this  topic  at  length, 
it  is  impossible  to  do  more  herein  than  present  one  of  the  rules 
for  calculating  the  average  due  date.  The  rule  given  relates 
to  the  product  method  of  ascertainment  since  it  is  believed  that 
this  method  is  simpler  than  any  other: 

Select  the  first  or  last  date  in  the  account  as  the  focal  date. 
Multiply  each  item  by  the  number  of  days  in  the  period  between 
the  due  date  of  the  item  and  the  focal  date  selected.  Add  the 
resultant  products,  securing  one  total  for  each  side  of  the 
account.  Subtract  the  smaller  total  from  the  larger  and  divide 
the  remainder  by  the  balance  of  the  account.  The  resulting 
amount  represents  the  number  of  days  that  the  average  due  date 
is  before  or  after  the  focal  date.  The  average  due  date  then  is 
determined  by  one  or  the  other  of  the  following: 

1.  If  the  focal  date  is  the  first  date  in  the  account: 

a.  If  the  dollar-days  balance  is  on  the  same  side  of  the 
account  as  the  balance  of  the  account,  count  forward. 

b.  If  the  dollar-days  balance  is  on  the  opposite  side  from 
the  balance  of  the  account,  count  backward. 

2.  If  the  focal  date  is  the  last  date  in  the  account: 

a.  If  the  dollar-days  balance  is  on  the  same  side  of  the 
account  as  the  balance  of  the  account,  count  backward. 

b.  If  the  dollar-days  balance  is  on  the  opposite  side  from 
the  balance  of  the  account,  count  forward. 

Fixed  and  Capital  Assets. — These  assets,  for  a  going  concern, 
should  be  valued  at  cost  less  depreciation.  The  following  points, 
relative  to  cost,  should  be  of  interest: 

1.  Cost  includes  all  expenses  incurred  up  to  the  moment  when 
the  asset  is  ready  for  use, — in  place,  ready  for  operation. 

2.  When  a  capital  asset  is  purchased. 

a.  Cost  would  include  such  items  as  cash  paid,  freight, 
duty,  insurance  in  transit,  drayage,  installation,  and  im- 
provements and  changes  made  necessary  to  make  such 
asset  suitable  for  the  use  to  which  it  is  to  be  put. 

b.  If  securities  have  been  issued  as  part  of  the  purchase 
price,  their  present  value,  plus  the  expenses  in  connection 
with  their  issue,  would  comprise  a  portion  of  the  cost 
price. 

c.  If  securities  have  been  issued  for  capital  assets,  as  often 


« 


\  i 


r 


i^^Uto 


36 


ADVANCED  ACCOUNTING 


is  the  case,  the  valuation  placed  upon  such  assets  by  the 
board  of  directors  is  final,  unless  fraud  can  be  proved, 
d.  Cash  discounts  secured  upon  the  purchase  of  capital 
assets  are  deducted,  generally,  from  the  invoice  cost 
thereof. 
3.  When  a  capital  asset  is  constructed. 

a.  Cost  would  include  such  items  as  material,  labor,  a  por- 
tion of  the  overhead,  fees  of  architect,  charges  for  licenses 
and  permits,  insurance  during  construction,  cost  of  in- 
juries and  accidents  to  workmen  engaged  upon  such 
work,  damages,  cost  of  strikes,  interest  on  borrowed 
money  during  construction  period,  bond  discount  during 
construction  period,  etc. 

b.  In  general,  even  though  bond  discount  and  the  expenses 
of  a  bond  issue,  should  be  spread  (amortized)  over  the 
period  during  which  the  bond  issue  is  outstanding, 
and  bond  discount  is  considered  as  partaking  of  the 
nature  of  bond  interest,  it  would  not  seem  justifiable  to 
capitalize,  as  part  of  construction  cost,  the  amortized 
portion  applicable  to  the  period  of  construction.  The 
same  is  true  of  bond  expense.  However,  some  account- 
ants do  not  approve  of  the  above  practice.  (See  bonds — 
post.  Chap.  8.) 

c.  If  the  construction  cost  is  less  than  market  price,  the 
asset  should  be  valued  at  cost;  a  saving  has  occurred, 
but  no  profit  has  been  made. 

d.  If  the  construction  cost  is  greater  than  market  price,  the 
asset  may  be  valued  in  either  one  of  two  ways: 

i.  Value  at  market  and  charge  the  excess  against  the 

current  net  profits, 
ii.  Value  at  cost  and  reduce  by  a  heavier  than  usual 
charge  against  the  Depreciation  account  so  that, 
when  the  Balance  Sheet  is  prepared,  the  net  carry- 
ing charge  will  be  reduced  to  the  present  appraised 
value. 
If  a  capital  asset  appreciates  in  value,  due  to  changes  in  the 
conditions  of  the  market,  such  appreciation  may  or  may  not  be 
booked,  probably  not: 

1.  If  not  booked.    An  unrealized  profit  should  not  be  booked. 


SPECIFIC  REAL  AND  NOMINAL  ACCOUNTS 


37 


A  Balance  Sheet  footnote  relative  to  such   appreciation 
may  be  desirable. 
2.  If  booked.    The  accountants  following  this  practice  main- 
tain that  a  Balance  Sheet  should  set  out  actual  values, 
regardless  of  cost.    Two  methods  of  booking  may  be  used: 

a.  Dr. — Asset  account  affected. 
Cr. — Reserve  for  Appreciation. 

The  above  credit  will  prevent  merging  the  amount  of  the 
appreciation  into  regular  Surplus  from  there  to  be  dis- 
tributed as  dividends. 

b.  Adjust  the  asset  to  present  replacement  value,  and  then 
adjust  the  Reserve  for  Depreciation  account  so  that  the 
net  carrying  value  will  equal  the  present  appraised  value. 

In  selling  a  capital  asset,  the  following  should  be  borne  in 
mind : 

1.  The  credit  should  not  be  to  the  regular  Sales  account. 

2.  The  booking  procedure  will  be  about  as  follows: 

a.  Charge  up  the  depreciation  from  last  closing  date  to  date 
of  sale  by  debiting  Depreciation  account  and  crediting 
Reserve  for  Depreciation  account. 

b.  Charge  Reserve  for  Depreciation  account  and  credit  the 
asset  account  affected  for  the  amount  standing  as  a 
credit  balance  in  the  Reserve  account;  this  entry  will 
eliminate  the  Reserve  account  amount  applicable  to  the 
asset  disposed  of  and  reduce  the  latter  to  a  net  figure. 

c.  The  amount  received  in  the  sale  then  should  be  credited 
to  the  asset  account  in  the  amount  necessary  to  clear  the 
account,  and  the  profit  or  loss  resulting  from  the  trans- 
action should  be  so  booked  that  it  will  not  affect  opera- 
tion results;  in  fact,  its  amount  is  a  credit  or  debit  to 
Surplus. 

Repairs — Renewals — Replacements — Additions — Better- 
ments.— These  items  bring  up  certain  points  that  are  more  or 
less  difficult  of  interpretation: 

1.  Repairs.  A  repair  is  a  replacement  of  a  part  of  a  unit  which, 
in  amount,  is  less  than  a  certain  figure.  A  repair  is  not 
supposed  to  increase  the  estimated  life  or  value  of  the 
repaired  asset ;  hence,  the  repair  amount  is  a  revenue  charge. 

2.  Renewals.     A  renewal  is  a  replacement  of  a  whole  unit. 


38 


ADVANCED  ACCOUNTING 


i 


The  worn  out  asset  should  be  cleared  from  the  books,  and 
the  new  asset  entered  thereon. 

3.  Replacements.  A  replacement  contemplates  the  removal 
of  a  worn  out  asset  and  the  purchase  of  a  new  one. 

4.  Additions.  An  addition  is  a  new  asset  which  does  not 
replace  any  asset  owned  previously. 

5.  Betterments.  If,  when  a  new  asset  is  purchased,  more  value 
is  represented  thereby  than  was  represented  by  the  asset 
replaced,  originally,  the  excess  represents  a  betterment. 

Wasting  Assets. — These  capital  assets  are  subject  to  both 
depreciation  and  depletion.  They  comprise  material  resources 
as  timber,  oil,  coal,  stone,  gold,  clay,  etc.,  properties.  The 
accounting  point  here  involved  relates  to  the  return  of  the  invest- 
ment to  the  proprietors, — stockholders  because,  as  the  prop- 
erties are  worked,  there  is  a  reduction  or  depletion  in  the  asset 
value  which  is  absorbed  by  the  profits.  The  accounting  treat- 
ment will  be  as  follows : 

1.  Depletion  may  be  disregarded  to  the  extent  that  when  divi- 
dends are  paid  a  portion  thereof  represents  a  return  of  the 
capital  investment. 

2.  Depletion  may  be  considered.  In  this  event,  a  periodic 
amount,  equal  to  the  proportion  that  the  amount  of  asset 
product  used  bears  to  the  total  estimated  amount  of  asset 
product  owned,  should  be  set  aside  in  a  Depletion  Reserve 
so  that,  when  the  entire  asset  product  owned  has  been  con- 
sumed, the  stockholders  may  have  their  capital  returned 
to  them. 

Take  a  mine,  for  example,  as  representing  a  wasting  asset  in 
which  many  people  are  interested.  When  so-called  profits  are 
paid  to  the  stockholders  in  the  form  of  dividends,  it  is  ques- 
tionable whether  or  not  these  dividends  really  represent  profits; 
usually,  a  portion  thereof  is  a  return  of  capital.  At  some  time 
or  other,  no  matter  how  rich  a  mine  may  be,  the  mine  either  will 
be  exhausted  or  it  will  become  so  difficult  to  work  that  it  will  not 
pay  to  do  so.  The  harder  the  mine  is  worked,  the  less  the  amoimt 
of  ore  that  remains ;  consequently,  due  to  thi's  working,  the  asset 
value  decreases.  Only  when  the  size  of  the  ore  body  is  ascertain- 
able, which  is  not  possible  as  an  ordinary  rule,  except  perhaps  in 
the  case  of  certain  coal  mines,  will  the  dividend  represent  only  a 


SPECIFIC  REAL  AND  NOMINAL  ACCOUNTS 


m 


distribution  of  profits;  hence,  practically  every  dividend  repre- 
sents an  unknown  portion  of  the  original  investment. 

Land.— In  addition  to  the  points  studied  in  connection  with 
the  earlier  work,  or  coextensive  therewith,  the  following  points 
are  offered  concerning  this  asset: 

1.  "Land,"  as  a  term,  is  not  synonymous  with  that  of  "real 
estate,"  since  the  latter  term  includes  both  land  and 
buildings. 

2.  Land  should  be  carried  in  an  account  separate  from  that  of 
buildings;  the  two  items  should  not  be  charged  to  the  same 
account,  even  when  purchased  together  for  a  specific  sum. 
The  separation  of  these  items  is  due  to  the  following  reasons: 

a.  Since  land,  originally,  does  not  depreciate,  whereas  build- 
ings do,  depreciation  could  not  be  calculated  unless  the 
two  ite'ms  are  separated. 

b.  Since  land  is  not  insured,  whereas  buildings  are,  the  sepa- 
ration should  be  made  so  that  a  basis  may  be  secured  for 
determining  insurable  value. 

3.  If  land  is  purchased  with  the  idea  of  selling  it  at  a  later 

date,  it  is  a  current  asset,  not  a  capital  asset. 

4.  Land  should  appear  in  the  accounts  at  its  fair  cash  value, 
when  acquired.  Such  value  would  consist  of  either  the 
actual  money  paid  therefor,  if  purchased  by  a  going  con- 
cern, or  its  fair  cash  value  if  taken  over  when  an  enterprise 
is  started;  also,  the  cost  of  any  permanent  improvements. 
If  interest  enters  in  relation  to  purchase  price,  the  actual 
amount  paid,  not  accrued,  may  be  regarded  as  a  portion 
of  the  cost. 

5.  Land  is  an  asset  only  when  owned,— at  least  covered  by  the 
term  "freehold  premises";  this  would  include  property  in 
which  there  is  only  a  life  interest.  Therefore,  if  a  plant 
receives  a  gift  of  land  upon  a  condition  that  must  be  ful- 
filled before  title  passes,  care  must  be  taken  to  book  prop- 
erly, if  at  all;  for  example: 

Dr.— Land— Contingent  Gift. 

Cr.— Reserve  for  Land— Contingent  Gift. 

Only  after  the  contingency  has  been  fulfilled,  should  the 

asset  be  taken  up  in  regular  order,  at  a  reasonable  appraised 

value,  offset  by  a  special  Surplus  account  which,  after  being 


40 


ADVANCED  ACCOUNTING 


charged  with  the  costs  entailed  by  the  gift,  may  be  trans- 
ferred to  regular  Surplus. 
Leaseholds. — If  land  is  held  under  a  lease,  one  which  is  a 
long-term  lease,  the  lease  may  or  may  not  be  booked.  It  should 
not  appear  in  the  accounts  unless  it  has  been  paid  for;  then  only 
at  the  price  paid  under  the  caption,  say,  of  Leasehold,  except  as 
under : 

1.  It  may  be  booked  at  its  present  value  in  a  statement  upon 
the  basis  of  which  the  property  is  offered  for  sale. 

2.  It  may  be  booked  in  the  same  manner  as  in  ( 1 ) ,  in  a  state- 
ment prepared  for  credit  purposes,  because  it  represents  an 
addition  to  net  worth.     A  leasehold  is  a  wasting  asset. 

Buildings. — This  item  is  an  asset  only  when  owned.  As  an 
asset,  its  booked  cost  may  include  every  expense  essential  in 
making  it  ready  for  occupancy.  The  following  items  are  illus- 
trative as  part  of  the  cost: 

1.  If  a  building  replaces  an  old  one  that  was  useless  when  a 
piece  of  land  was  purchased,  and  was  not  considered  in  the 
purchase  price,  the  cost  of  tearing  down  the  old  structure 
is  a  legitimate  charge  to  the  cost  of  the  new  one. 

2.  The  sum  paid  to  a  tenant  holding  a  lease  upon  such  old 
building  which  expires  beyond  the  time  when  the  old  building 
is  to  be  razed. 

3.  Interest  on  money  paid  to  contractors  during  construction 
period. 

4.  Insurance  and  taxes  up  to  the  time  when  the  new  structure 
is  ready  for  occupancy. 

5.  Value  paid  for  a  building,  whether  in  cash,  in  stock,  or  in 
bonds. 

6.  Additions  to  cost  which  distinctly  add  to  the  value  (better- 
ments), or  the  excess  cost  of  replacement  value  over  the 
cost  of  the  element  replaced. 

7.  If  bonds  are  sold  at  a  discount  to  provide  funds  to  erect 
a  building,  the  amount  of  such  discount  should  not  be 
charged  to  building  cost. 

As  to  depreciation,  care  should  be  taken  in  determining  the 
amount  thereof,  especially  relative  to  variations  applicable  to 
different  portions  of  a  building.  If  one  part  of  a  building  is  used 
for  purposes  other  than  those  applicable  to  another  portion  of 


SPECIFIC  REAL  AND  NOMINAL  ACCOUNTS  41 

the  building,  it  will  be  necessary  to  keep  the  cost  of  the  different 
portions  separate  one  from  the  other,  since  the  amount  of  depre- 
ciation on  each  part  will  not  be  similar;  for  a  like  reason,  it 
may  be  desirable  to  book  the  cost  of  foundations  separate  from 
the  superstructure,  since  the  former  will  depreciate  but  slightly, 
if  at  all. 

If  a  person  owns  a  building  for  life  only,— has  a  freehold  in- 
terest therein,  depreciation  may  be  ignored  unless  he: 

1.  Expects  to  live  beyond  the  point  of  time  that  the  building 
is  serviceable,  or 

2.  Expects  to  leave  the  property  when  the  building  no  longer 
is  usable  for  his  purposes,  or 

3.  Expects  to  replace  the  building  in  whole  or  in  part. 
Again,  under  the  circumstances  where  a  building  is  on  leased 

ground,  and  the  condition  exists  that  title  to  such  building  passes 
to  the  owner  of  the  land  upon  termination  of  the  lease,  the  en- 
tire building  value  should  be  charged  off  annually  upon  a  pro 
rata  basis  during  the  life  of  the  lease.  Finally,  when  a  building 
IS  leased  and  the  lessee  is  required  to  expend  money  thereon 
m  order  to  prepare  it  for  use,  the  cost  of  such  additions  and 
improvements  should  be  spread  over  the  life  of  the  lease  as 
an  addition  to  the  rental  charge;  where  the  lease  has  expired, 
these  additions  and  improvements  become  the  property  of  the 
owner. 

Machinery.— This  asset  should  be  booked  at  a  value  that  will 
mclude  not  only  the  purchase  price  but  all  legitimate  expenses 
necessary  to  place  it  upon  a  production  basis,  as:  in  freight  and 
cartage  thereon,  setting  up  labor  and  expenses,  and  labor  charges 
related  to  experimenting  and  testing  up  to  the  point  where  the 
machme  runs  true  to  form. 

When  machinery  is  purchased  upon  the  installment  plan,  title 
not  passmg  until  a  certain  number  of  payments  have  been  made 
a  problem  arises  as  to  the  proper  recording  of  the  payments  as 
between  capital  and  revenue,  since  interest  is  included  as  a  por^ 
tion  of  each  payment  made: 

a.  Determine  the  cash  price  of  the  asset,  and  the  interest 
rate,  and  by  means  of  tables  ascertain  the  periodic  per- 

charges      '"'''"'""'  '"''''"''  '"''  '''''  ''P''^'^'  ^-^-^e, 


42 


ADVANCED  ACCOUNTING 


I 
I 


b.  Book  the  entire  cost  of  the  asset,  by  a  charge  to  the 
proper  asset  account  and  a  charge  for  interest  to  a  de- 
ferred charge  to  operating  account,  offset  by  a  credit  to 
a  liability  account. 

c.  Where  each  payment  is  made,  periodically: 

i.  Charge  the  liability  account  and  credit  cash,  and 
ii.  Charge  Interest  Expense  account  and  credit  the 
deferred    charge    to    operating    account    for    the 
interest  portion. 

When  machinery  is  made  by  the  factory  itself  its  value,  as 
recorded,  should  consist  of  the  actual  material  cost,  labor  cost, 
and  a  fair  amount  of  the  factory  overhead.  If  this  total  value 
is  less  than  the  cost  necessary,  should  the  machinery  be  pur- 
chased, the  difference  represents  a  saving,  not  a  profit;  this 
saving  will  be  realized  eventually  by  the  smaller  yearly  deprec^i- 
ation  charge  against  profits. 

When  machinery  is  moved  from  one  place  to  another  within 
a  plant,  the  cost  incurred  may  be  booked  separately  and  be 
spread  over  the  period  estimated  as  representing  the  life  of  the 
saving  caused  thereby. 

If  the  machinery  items  are  not  numerous,  one  or  more  accounts 
may  be  carried  therefor  upon  the  General  Ledger,  as  desired. 
If  only  one  account  be  carried,  and  no  subsidiary  Ledger  used  to 
hold  the  detail  accounts,  a  book  memo  should  be  used  in  which  a 
detailed  list  of  the  items  may  be  found ;  otherwise,  depreciation 
cannot  be  calculated  as  it  should  be  and,  in  case  of  fire,  it  would 
be  difficult  to  prove  the  amount  of  the  loss.  It  would  seem  de- 
sirable, in  nearly  all  cases,  to  carry  one  Machinery  account  upon 
the  General  Ledger  to  act  as  a  control  over  a  so-called  card 
Ledger  or  file  in  which  each  card  covers  one  specific  machine 
or  other  unit  of  property  covered  by  the  title  "machinery,"  as: 
boilers,  shafting  and  pulleys,  belting,  etc. 

Tools.— This  asset  should  represent  the  miscellaneous  small 
articles  that  are  used  directly  on  the  material  which  is  being 
fabricated  into  manufactured  product,  as:  hammers,  chisels,  etc  , 
which,  when  used,  are  held  either  in  the  hand  or  fastened  to' 
a  machine  in  some  way.  They  should  be  carried  in  an  account 
separate  from  that  of  Machinery. 

Since  the  depreciation  of  tools  by  the  application  of  a  fixed 


SPECIFIC  REAL  AND  NOMINAL  ACCOUNTS 


43 


rate  cannot  be  determined  m  any  manner  that  approaches  ac- 
curacy, due  to  the  fact  that  the  uses  to  which  a  tool  may  be 
put  are  numerous  and  varied,  it  is  customary  to  handle  the 
reduction  in  value  other  than  in  a  manner  similar  to  that  applied 
usually.  In  other  words,  when  the  books  are  closed,  tools  should 
be  revalued  and  the  book  value  thereof  reduced  to  such  amount. 
Patterns.— This  asset  may  be  of  considerable  importance  in 
a  manufacturing  concern,  in  that  it  may  represent  a  fairly  large 
sum  of  money.  Actual  or  frequent  use  would  seem  to  be  the  test 
of  whether  or  not  a  pattern  has  value.  And  even  so,  the  cost  of 
stock  patterns  should  be  depreciated  liberally.  Special  patterns 
used  in  connection  with  a  specific  piece  of  work  should  be  charged 
thereto  as  part  of  its  cost.  When  a  new  design  replaces  one  that 
has  been  used,  the  old  patterns  should  be  dropped  from  the 
books  unless  there  still  exists  a  sale  for  articles  of  the  old  type ; 
even  so,  it  may  be  advisable  to  carry  them  only  at  a  mere 
nominal  amount. 

Good-will— Patents— Royalties— Copyrights— Trade- 
marks, etc.— Good-will  will  be  discussed  in  considerable  detail 
later  in  connection  with  consolidated  statements;  hence,  only 
two  points  will  be  mentioned  at  this  time: 

1.  Good-will  may  be  said  to  represent  or  measure  "the  earn- 
ing capacity  of  a  business  in  excess  of  a  given  rate  of  profit 
recognized  as  normal."  This  definition  will  answer  for  the 
use  of  this  intangible  capital  asset  in  connection  with  the 
general  corporate  work  discussed  in  subsequent  chapters. 

2.  Good-will  should  be  recorded,  if  at  all,  at  its  exact  cost 
and  only  when  purchased.  This  must  be  taken  as  a  general 
statement  only,  in  that  the  amount  of  good-will  as  origi- 
nally booked  may  be  reduced,— or  may  not  be  made  use 
of  at  all  in  an  account  by  that  name,  as  when  adjustments 
thereof  are  made  against  specific  asset  accounts.  (See 
Treasury  Stock,  post). 

Patents  present  considerable  difficulty  in  the  matter  of  valua- 
tion; however,  an  accountant  should  be  governed  only  by  what 
seemingly  has  been  paid  for  them.  In  general,  the  following 
summary  will  cover  the  item: 

1.  A  patent  should  be  recorded  at  cost: 

a.  The  purchaser  of  a  patent  would  book  it  at  its  cost 
to  him. 


I 


44 


ADVANCED  ACCOUNTING 


b.  The  inventor  would  record  it  at  a  cost  composed  of  : 

i.  Cost  of  producing  the  invention, 
ii.  Legal  fees  involved. 

c.  The  owner  of  a  patent  may  consider  as  part  of  its  cost 
the  expenses  incurred  in  protecting  it  from  infringement. 

A  patent  has  no  value  until  it  is  shown  to  be  valid. 

2.  Patents  should  be  depreciated  heavily,  regardless  of  use 
and  of  new  patents  which  may  be  secured  upon  improve- 
ments which  tend  to  prolong  the  life  of  the  original  patent 
beyond  the  usual  seventeen  years.  It  is  a  wasting  asset. 
A  patent  may  prove  of  no  practical  value  within  a  short 
time  due  to  lack  of  demand  for  the  product  resulting  from 
its  use  or  due  to  the  fact  that  something  new  and  better 
has  been  placed  on  the  market  by  another.  Patents  are 
considered  as  expiring  in  seventeen  years,  but  when  this 
period  of  life  is  used,  it  would  seem  conservative  to  set  up 
a  reserve  to  cover  the  contingency  of  possible  obsolescence 
due  to  better  patents  issued  to  others,  in  addition  to  the 
annual  credit  made  directly  against  the  asset. 

3.  The  patent  expense  on  machinery  used  in  producing  a  cer- 
tain manufactured  product  is  a  manufacturing  cost,  where- 
as, if  the  patent  covers  the  article  sold,  its  expense  is 
chargeable  as  a  selling  cost. 

Royalties  received  are  non-operating  income,  whereas,  royal- 
ties paid  in  connection  with  the  use  of  a  patent  are  manu- 
facturing expenses  chargeable  under  the  same  principles  that 
govern  the  handling  of  patent  expense.  The  royalty  contract 
must  be  carefully  scrutinized  before  an  attempt  is  made  to  make 
entries  therefor.  Where  a  certain  minimum  royalty  has  been 
guaranteed  the  holder  of  the  patent,  as  a  total,  and  the  actual 
amount  due  on  account  of  operations  is  less  than  this  minimum 
guaranteed  total,  the  excess  must  be  treated  as  a  deferred  charge 
to  be  written  off  later  against  future  operations,  provided  the 
royalty  contract  permits. 

Formulas  or  trade  secrets  should  be  booked  at  cost,  and  be  de- 
preciated heavily,  especially  if  not  protected.  Their  value  is 
related  closely  to  the  article  produced  inasmuch  as  there  will 
be  no  value  if  the  article  produced  has  no  value. 

Copyrights  and  trademarks  should  be  recorded  at  cost,  if  at 
all,  and  should  be  depreciated  heavily  beyond  the  amount  which 


SPECIFIC  REAL  AND  NOMINAL  ACCOUNTS  45 

would  be  required  by  following  the  number  of  years  for  which 
each  is  granted: 

1.  Copyrights  are  granted  for  twenty-eight  years,  and  may 
be  renewed  for  a  similar  period,  under  certain  conditions 
Very  few  copyrighted  articles  have  any  value  at  the  end 
of  twenty-eight  years. 

2.  Trademarks,  when  registered,  are  protected  indefinitely 
provided  they  are  used  continuously.  It  is  not  usual  tc^ 
book  a  value  for  a  trademark  unless  it  has  been  purchased. 

A  license,  as  to  cost,  is  a  deferred  charge  to  be  written  off 
over  the  period  for  which  the  license  was  granted. 

A  franchise  should  be  recorded  at  cost.  The  matter  of  de- 
preciation depends  upon  circumstances: 

1.  If  perpetual— no  depreciation. 

2.  If  for  a  definite  period-depreciate  in  proportion  to  time 
elapsed. 

3.  If  indefinite — depreciate  heavily. 

Notes  Payable.-This  type  of  liability  may  be  classified  in 
two  different  ways: 

1.  First  classification: 

a.  Those  with  collateral. 

b.  Those  without  collateral. 

2.  Second  classification: 

a.  Those  issued  for  merchandise. 

b.  Those  discounted  by  banks. 

c.  Those  sold  through  brokers. 

d.  Demand  loans. 

e.  Those  of  officers  and  employees. 

f.  Purchase  money  notes. 

g.  Accommodation  notes. 

as^t."'^^  °?i''  ""^""^  ^°"P  "^y  ^  subdivided  further 

b^tlte"'  '"^  """  '"'^  ^'^^  ^'  ^  *^«  ~t  secured 

A  note  given  for  accommodation  creates  both  a  contin^pnt 

rT  pTtrmTf  "^'"^*^-    ^"  ^^"^^^•'  ^'*h-«h  nTe'E 
P^eferabk  to  r.  "T  T^  '  transaction,  it  would  seem 

preierable  to  make  some  book  record  thereof,  as: 

Dr.    Accommodation  account 
Cr.    Liability  as  Indorser 


46 


ADVANCED  ACCOUNTING 


especially  where  an  exchange  of  notes  has  taken  place.  Even 
when  a  note  has  been  indorsed  as  an  accommodation,  it  is 
possible  to  make  use  of  the  above  entry  inasmuch  as  this  act, 
also,  creates  both  a  contingent  asset  and  a  contingent  liability. 
When  a  time  draft  has  been  accepted,  it  should  be  booked  as 
a  Note  Payable. 

Accounts  Payable.— As  concerns  this  liability,  some  of  the 
points  mentioned  already  in  connection  with  accounts  receivable 
are  applicable.  The  term,  as  a  title,  should  not  be  used  as  a 
Ledger  account  heading  except,  perhaps,  under  the  two  following 
conditions: 

1.  As  the  title  of  the  controlling  account  over  the  creditors' 
Ledger. 

2.  As  the  title  of  an  account  upon  the  General  Ledger  to  which 
is  posted  monthly  the  total  of  all  credit  transactions,  no 
separate  creditors'  accounts  being  carried. 

Practice,  at  least,  will  advocate  the  use  of  this  term  under 
the  above  conditions  even  though  the  caption  Creditors'  Accounts 
or  Trade  Creditors  would  seem  preferable. 

Three  methods  exist,  in  general,  for  carrying  the  open  accounts 
with  business  creditors: 

1.  All  transactions  of  each  month  are  posted  as  a  credit  to  one 
account  upon  the  General  Ledger,  which  is  given  some 
descriptive  title.  Hereunder,  all  creditors  are  treated  as 
but  a  single  creditor,  due  to  the  fact  that  as  long  as  a  busi- 
ness owes  money,  it  is  really  immaterial  to  whom  the  money 
IS  owed.  Accounts  receivable  should  not  be  handled  in  this 
way,  under  any  circumstances,  since  the  credit  standing  of 
each  customer  is  a  most  important  consideration  in  deter- 
mming  whether  or  not  more  money  is  owed  the  business  by 
such  customer  than  should  be  owed,  and  whether  or  not 
such  customer  pays  promptly. 

2.  Each  creditor  is  given  a  separate  account,  usually  upon  a 
subsidiary  Ledger,  the  latter  being  controlled  by  an  account 
upon  the  General  Ledger. 

3.  Combination  of  (1)  and  (2).  Certain  creditors  are  given 
separate  accounts  so  that  the  volume  of  business  with  each 
such  may  be  determined  readily,  whereas,  concerning  the 
others,  one  general  account  to  cover  all  may  be  sufficient 


SPECIFIC  REAL  AND  NOMINAL  ACCOUNTS  47 

Naturally,  hereunder  it  is  necessary  to  columnize  the  original 
records  so  that  the  above  separation  is  made  possible  readily. 

Purchases.-Purchases  and  sales,  and  the  various  accounts 
closely  allied  thereto  should  not  be  recorded  in  the  old-style 
Merchandise  account,  but  should  be  so  recorded  that,  from  the 
accounts  used,  an  intelligent  statement  thereof,  leading  to  a 
figure  representing  gross  profit,  may  be  prepared  without  the 
necessity  of  recasting  the  accounts. 

To  the  extent  that  a  concern  is  liable  for  the  purchase  price  of 
the  material,  the  bookkeeper  should  make  proper  records  thereof- 
this  means  that  all  unrecorded  purchases  of  the  kind  above 
referred  to,  when  statements  are  drawn,  should  be  considered  as 
increasing  the  Purchases  account,  the  Inventory  and  the  Accounts 
Payable. 

The  form  of  the  Purchase  Book  depends  upon  the  organization 
under  review.     Purchases  may  be  classified  by  kinds  of  mate- 
rial, or  by  departments,  m  not  at  all.     It  may  be  desirable  to 
use  a  Voucher  Record  in  preference  to  a  Purchase  Book-  the 
latter  has  been  described  briefly  in  the  preceding  chapter     Under 
either  possibility,  it  is  necessary  to  have  the  right  side  of  the 
Cash  Book  provided  with  columns  in  which  payments,  and  cash 
discounts  (unless  the  latter  are  taken  up  on  the  Purchase  Record 
or  Voucher  Register) ,  may  be  entered.    Provision  should  be  made 
for  postmg  the  items  from  this  side  of  the  Cash  Book  to  the 
proper  lines  of  the  Purchase  Record,  even  though  the  regular 
creditors  Ledger  is  used  to  which  postings  are  made  in  regular 
form;  naturally,  when  a  Voucher  Record  is  operated,  this  post- 
mg  to  the  proper  lines  thereon  will  be  the  only  posting  made, 
unless  certain  creditors  are  carried  in  special  detail  accounts 

Returns  and  allowances,  related  to  Purchases,  should  be  entered 
upon  a  separate  record;  if  not,  the  General  Journal  must  contain 

nn  ff       j:';^^.^^^^  the  General  Journal  should  contain  a  column 
a  in!  7^^^f  ^  ^^^  adjustment  purposes;  in  fact,  even  where 

columns  on  the  General  Journal  may  be  desirable  to  take  care 
01  possible  miscellaneous  adjustments. 
In  proving  up  the  accounts  payable,  where  both  a  Purchase 


48 


ADVANCED  ACCOUNTINO 


SPECIFIC  REAL  AND  NOMINAL  ACCOUNTS 


49 


Record  is  used  as  above  indicated,  and  a  Creditors'  Ledger  is 
maintained,  a  double  check  is  secured  upon  the  work: 

1.  List  the  open  items  upon  the  Purchase  Record  and  secure 
their  total. 

2.  This  total  should  agree  with  the  balance  of  the  controlling 
account  upon  the  General  Ledger. 

3.  This  total  should  agree  with  the  total  of  the  Trial  Balance 
or  abstract  of  the  Creditors'  Ledger. 

The  procedure  revolving  around  the  placing  of  a  purchase 
order,  the  receipt  of  the  invoice  and  the  goods,  and  the  book- 
keeping involved,  are  dependent  upon  the  particular  concern 
under  scrutiny.  On  the  one  hand,  the  whole  procedure  may  be 
decidedly  simple  and,  on  the  other,  it  may  be  more  or  less 
involved  or  complicated.    The  following  example  will  suffice: 

1.  When  the  storekeeper  discovers  a  certain  material  has 
reached  the  minimum  quantity  that  must  be  on  hand  at  all 
times,  he  notifies  the  purchasing  department  by  means  of  a 
Purchase  Requisition,  keeping  a  6arbon  copy  on  file  and 
making  entry  of  such  notification  upon  his  Stores  Ledger. 

2.  When  the  purchasing  department  receives  this  requisition, 
an  order  is  placed,  after  the  usual  preliminaries  have  been 
met,  by  means  of  a  Purchase  Order,  made  in  quadruplicate: 

a.  Original  to  vendor  as  authority  to  ship. 

b.  Duplicate  retained  and  filed  with  Purchase  Requisition. 

c.  Triplicate  to  receiving  department,   as   notification  to 
expect  shipment. 

d.  Quadruplicate  to  storekeeper,  who  may  make  entry  in 
the  Stores  Ledger  account  in  a  section  for  such  purpose. 

3.  When  the  vendor  receives  the  Purchase  Order,  he  ships 
the  material  and  sends  along  an  invoice  which,  when  re- 
ceived in  Purchasing  Department,  is  filed  with  the  copy  of 
the  Purchase  Order  there  held. 

4.  When  the  material  is  received,  the  receiving  clerk  will  make 
out  a  Report  of  Material  Received,  after  inspection,  per- 
haps, consisting  of  three  copies : 

a.  Original  to  purchasing  department. 

b.  Duplicate  to  be   sent  storekeeper  with   material   after 
same  has  been  cleared. 


c.  Triplicate  to  be  retained  in  the  files,  after  being  receipted 
by  storekeeper. 

5.  When  the  purchasing  agent  receives  his  copy  of  the  Report 
of  Material  Received,  it  is  compared  with  the  Purchase 
Order  and  the  invoice  on  file,  after  which  the  material  is 
cleared  to  the  control  of  the  storekeeper.  Perhaps  the  mate- 
rial goes  immediately  to  storekeeper  after  inspection. 

6.  The  invoice  then  is  indorsed,  and  is  forwarded  to  the 
accounting  department  for  entry  and  payment. 

Sales.— All  sales  orders  should  be  recorded  systematically. 
Before  a  sales  invoice  is  sent  out,  it  should  be  checked  against 
the  sales  order.  Likewise,  the  shipping  clerk  should  keep  a  sepa- 
rate record  of  all  shipments  made. 

The  usual  form  of  Sales  Book  should  consist  of  a  binder  in 
which  are  contained  carbon  copies  of  the  invoices  sent  customers. 
The  detail  postings  are  made  from  these  carbon  copies,  whereas, 
the  control  account  posting  and  the  sales  distribution  would  be 
secured  from  what  might  be  called  a  Sales  Journal  which,  prac- 
tically,  might  better  be  termed  a  Recapitulation  of  Sales. 

A  summary  presentation  of  some  of  the  principles  of  use  in 
connection  with  various  kinds  of  sales  seems  in  order: 

1.  Cash  sales.  Great  care  must  be  exercised  to  ascertain  that 
the  proper  system  of  internal  audit  is  in  use.  (See  previous 
discussion  relative  to  cash  receipts.)  One  means  of  taking 
care  of  cash  sales  is  to  handle  them  in  about  the  same  way 
as  credit  sales,  but  in  totals.  A  separate  column  is  pro- 
vided upon  the  sales  recap  sheet,  and  herein  each  cash  sale 
IS  entered  and  distributed  in  the  same  manner  as  the  charge 
sales  are  distributed.  The  total  of  this  column  is  charged  to 
the  Cash  Sales  account.  A  similar  column  is  provided  on 
the  Cash  Book  to  hold  the  amount  of  payments  received 
from  cash  customers.  The  total  of  this  column  is  credited 
to  the  Cash  Sales  account.  A  credit  balance  in  this  account 
represents  cash  received  for  which  goods  have  not  been 
delivered. 

2.  Sales  to  proprietor.    These  may  be  handled  in  either  one  ot 
two  ways: 


50 


ADVANCED  ACCOUNTINQ 


a.  Dr.  Personal  Account — Proprietor,  I  i 

Cr.  Purchases,  $  i 

At  cost  price. 

b.  Dr.  Accounts  Receivable  (Detail  and 

control),  $  i 

Cr.  Sales. 

At  cost  price,  $  fi 

Dr.  Personal  Account — Proprietor,  $  ^ 

Cr.  Accounts  Receivable  (Detail 

and  control),  $  f5 

To  clear  from  Accounts  Receivaliie. 
Dr.  Sales.  $  i 

Cr.  Purchases,  $  j6 

To  clear  from  Sales  account. 
This  entry  is  unnecessary  unleii 
the  aggregate  is  of  sufficient  size 
to  afTect  sales  statistics. 

3.  Instalment  sales.    The  following  entries  are  illustrative: 


$  ^ 


Dr.  Instalment  Accounts  Receivable — 19 — 
Cr.  Cost  of  goods  sold, 

Unrealized  Gross  Profit — Instal- 
ment Accounts  Receivable — 19 — 
To  record  the  sale. 
Dr.  Cash,  $  ^ 

Unrealized  Gross  Profit — Instalment. 
Accounts  Receivable — 19 — ,  $  ^ 

Cr.  Instalment  Accounts  Receivable — 

Realized  Gross  Profit — Instalment 

Accounts  Receivable — 19 — , 

To  record  payment  on  account. 

Dr.  Realized  Gross  Profit — Instalment  Ac- 
counts Receivable — 19 — ,  $  i 

Cr.  Profit  and  Loss, 
To  close. 


$ 


$  i 


$  i 


} 


The  hire-purchase  plan  contemplates  renting  an  article  to  the 

would-be-purchaser  under  an  agreement  that ,  when  the  required 

number  of  instalments  have  been  paid  as  rent,  a  bill  of  sale  will 

be  given  for  the  article.    Title  does  not  pass  until  all  payments 

have  been  made,  and  if  a  payment  is  defaulted,  the  owner  may 

recover  possession  of  the  article  under  the  lease  terms. 

4.  Sales  on  approval.    No  sale  has  taken  place  until  the  goods 

have  been  accepted.     Therefore,  the  following  entries  would 

suffice: 


SPECIFIC  REAL  AND  NOMINAL   ACCOUNTS 


51 


I  i 


ti 


s  i 


S  f< 


I  ^ 


$  i 


Dr.  Approval  Accounts  Receivable, 
Cr.  Approval  Sales, 

To  record  sale  at  sales  price     . 
Dr.  Approval  Sales, 

Cr.  Approval  Accounts  Receivable, 
To  record  goods  returned. 
t)T.  Cash  (or  Accounts  Receivable)  {  Same    ' 
Approval  Sales  J  Amount, 

Cr.  Sales  j  s&me 

Approval  Accounts  Receivable )  Amount, 
To  record  actual  sale  of  goods. 

Goods  out  on  approval  are  part  of  the  establishment  inventory 

and  care  must  be  observed  to  provide  for  more  than  usual  loss  in 

value  here  agamst  when  the  periodical  statements  are  prepared 

5.  C.  O  D.  sales.    Regular  entries  upon  the  books  of  account 

should  be  made  to  cover  these  sales  rather  than  mere  memo 

entries : 

Dr.  C.O.D.  Account,  •  ^ 

Cr.  Sales,  ^   , 

To  record  C.O.D.  sale. 
Dr.  Cash,  *    . 

Cr.  C.O.D.  Account,  m  j 

To  record  collections. 
Delivery  drivers  are  charged  for  all  C.  O.  D.  goods  to  be 
delivered  by  them,  and  offsetting  credits  are  made  only  for  cash 
received  or  goods  returned.    Adjust  the  C.  O.  D.  account  against 
the  bales  account  at  closing  time. 

6.  Sales  to  branches.  These  are  not  regular  sales,  being  ordi- 
nary  shipments;  therefore,  credit  such  sales  to  a  Shipment 
account:  ^ 

Dr.  Branch — A  ^    . 

Cr.  Branch  Shipments,  «   j 

On  the  branch  books,  the  offsetting  entry  would  be: 
Dr.  Purchases  (goods), ^  «  ^ 

Cr.  Home  Office^  ^    . 

Goods  are  billed  to  branches  at  cost  or  at  some  figure  other 

ment  mf  ;f ''  'f "  ""'"''''  "^  ^°"°"^^'  ^  P-^^icS  adjus  ^ 
ment  must  be  made  on  the  books  of  the  home  office  to  take  up 
the  inventory  of  the  branch  at  cost  '^ 

^'  fhtV°'.  f "*">•«  delivery.  Nothing  need  be  said  concerning 
this  kind  of  sales  unless  a  contract  exists  under  which  a 
customer  can  be  sued.    If  such  contract  exists; 


52 


ADVANCED  ACCOUNTING 


I 


a.  The  sale  may  be  recorded,  provided  tlie  goods  are  in 
stock  ready  for  shipment,  even  though  there  be  a  delay 
in  delivery. 

b.  The  sale  should  not  be  recorded  if  the  goods  involved 
have  not  been  fabricated. 

However,  it  is  usual  not  to  record  such  sales  until  delivery 
has  been  made.  Selling  expenses  applicable  to  sales  not  delivered 
may  be  deferred  in  closing  the  books. 

8.  Sales  on  consignment.  Title  to  goods  sent  out  on  consign- 
ment has  not  passed;  therefore,  consignment  sales  are  not 
regular  sales.  The  entries  covering  consignments  are  illus- 
trated below,  as  to  one  method: 


Books  of  Consignor: 

A .  B. — Consignment. 

To — Goods  on  Consignment 

(A.B.). 
To  record  goods  shipped. 
A.B. — Consignment. 

To — Accounts  Payable  (cash). 
To  record  charges  incurred, 
as  freight,  insurance,  dray- 
age,  etc. 
A.B. — Personal. 

To — ^A.B.  Consignment. 

Gross  proceeds  as  per  ac- 
count sales. 

A .  B. — Consignment. 
To— A.B.  Personal. 

Expenses  and  commission 
as  per  account  sales. 
A  .B. — Consignment. 
To — Profit  and  Loss. 

Profit  on  consignment  after 
unsold  goods  have  been  en- 
tered on  the  credit  side  of 
A.B.  Consignment  account. 
Cash. 
To — ^A.B.  Personal. 

Receipt  of  cash  to  balance 
A.B. — Personal  account. 

Goods  on  Consignment  (A.B.). 
To — Profit  and  Loss. 
To  close. 


Books  of  Consignee: 

Dr.  None. 
Cr.  None. 
Memo  entry  made  only. 

XY — Consignor. 
To — Accounts  Payable  (cash). 
To  record  all  expenses  in- 
curred  f)ii   behalf   of   con- 
signor. 
Accounts  Receivable  (cash). 
To— XY— Consignor. 

To  record  sales  made. 

XY — Consignor. 
To — Commission. 

To   record   commission 
charged. 
Commission 

To — Profit  and  Loss. 

To  close  out  gross  profit. 


XY — Consignof. 
To— Cash 

Payment  of  cash  to  bal- 
ance XY — Consignor  Ac- 
count. 


SPECIFIC  REAL  AND  NOMINAL  ACCOUNTS  53 

9.  Loss  in  transit.  At  times,  goods  are  lost  in  transit  while  on 

It  foil  f  ■      ™  ^  '"^^^  *°  *•>«  '*"™ad  company 

the  foUowmg  entries  may  result: 

Blank  Railroad  Company, 
To— Goods  Lost  in  Transit, 
To  record  claim  made. 
Cash, 

To— Blank  Railroad  Company, 
To  record  receipt  of  damages. 
Goods  lost  in  Transit, 
To— Sales, 

This  entry  is  made  when  damages  are  received. 


»  t 


*t 


S  i 


t  t 


%i 


t  i 


Likewise,  the  value  of  the  goods  lost  in  transit  should  be  set 
out  as  such  as  part  of  the  inventory,  prior  to  receipt  of  damals 
or  recovery  of  the  goods.  ^        aamages 

10.  Sales  guaranteed.  When  goods  sold  carry  a  guaranty  such 
guaranty  is  a  contingent  liability,  wh^h  Sght  be'  pr^ 
vided  for,  as  to  loss,  by  a  periodical  charge  to  Profit  and 

SalesTo  P  '"'  '  ''''''  *«  «  "^'^'''t'^  '-erve  account 

Sales  to  Foreign  Branches.-The  subject  of  foreign  branches 

polntTrr    "''  "  """""°"  *''^^^^*''  '^  -ffi^-%  im- 
portant to  require  a  separate  chapter.    However  thf>  fnliL- 

points  are  deemed  sufficient  for  preLt  purZI  """'" 

1.  Arbitrage  relates  to  the  method  of  remitting  to  one  foreien 
country  through  another  foreign  country  so  as  to  LkeT 
vantage  of  current  foreign  exchange  rates. 

^s'"us'uIlT"''  'T  correspondent  in  a  foreign  country. 
It  IS  usual  to  carry  the  account  therewith  in  a  Ledger  ac- 
count naled  with  two  debit  and  two  credit  columns  The 
jns.de  debit  and  credit  columns  are  used  for  showTng  va^ue 
in  the  foreign  currency.  When  the  balances  are  drawn  the 
amounts  are  calculated  at  the  exchange  rat^  aT  of '   L 

batTedr*  '^*^-     ^''^  *^°  ^^^  ofUmns  then 

a.  P^fit  and  i^^^^^^^^  '*'"°'"*  "'^^  ^  -^t^"  o^  to: 
b   Reserve  for  Exchange  Fluctuations. 


.*• 


I, 


I 


54  ADVANCED  ACCOUNTING 

4.  The  current  assets  of  a  foreign  branch  should  be  brought 
upon  the  books  of  the  home  office  at  their  realizable  value 
in  American  money. 

5.  Remittances  to  a  foreign  branch  should  be  booked  by  the 
home  office  at  actual  cost, — rates  paid. 

6.  Revenue  items  should  be  converted,  upon  the  home  office 
books,  at  the  average  rate  for  the  period. 

7.  The  controlling  account  on  the  home  office  books  should 
be  calculated  at  the  same  rate  as  that  established  at  the 
last  period. 

8.  When  a  branch  receives  a  shipment  from  the  home  office, 
the  latter  should  be  recorded  on  the  branch  books  at  actual 
cost. 

Returns  and  Allowances;  Expenses  Related  to  Goods. — 
Purchase  Returns  are  deductions  from  Purchases,  and  Sales  Re- 
turns are  deductions  from  Sales.  Separate  Journals  should  be 
used  for  each  class  of  returns  rather  than  recording  them  in  the 
regular  Purchases  and  Sales  Books.  Allowances  on  Purchases 
and  on  Sales  may  be  combined  with  the  Returns  on  IHirchases 
and  on  Sales,  respectively,  although  some  accountants  maintain 
that  returns  should  be  booked  separately  from  allowances. 

Freight  and  cartage  outward  may  be  handled  in  either  one  of 
two  possible  ways: 

1.  If  goods  are  sold  f.  o.  b.  destination,  such  expenses  may  be 
considered  as  sales  deductions. 

2.  If  goods  are  not  sold  under  these  terms,  but  as  f.  o.  b.  point 
of  shipment,  such  expenses  may  be  considered  as  selling 
expenses. 

Purchasing  department  expenses  are  related  to  the  cost  of 
purchases,  whereas  credit  department  expenses  are  considered 
either  as  selling  or  administrative  expenses,  preferably  the  latter. 

Ordinarily,  warehouse  expenses  are  considered  as  selling  ex- 
penses, but  at  times  it  may  be  advisable  to  apportion  part  of 
them  as  a  cost  of  purchases.  Advertising  expenses  are  not  always 
to  be  charged  off  currently  to  Profit  and  Loss: 

1.  Current  advertising  never  should  be  considered  except  as  a 
current  selling  expense. 

2.  Heavy  outlays  connected  with   an  advertising  campaign 


SPECIFIC  REAL  AND  NOMINAL  ACCOUNTS  55 

may  be  considered  as  a  deferred  charge  to  be  written  off 
over  a  short  period  of  time. 

Trade  and  cash  discounts  present  a   few  points  that  seem 
worthy  of  being  reviewed: 

1.  The  correct  treatment  of  trade  discounts,  deductions  from 
list  prices,  depends  upon  circumstances: 

a.  Ordinarily,  they  should  be  deducted  from  the  invoices 
so  as  not  to  be  taken  up  on  the  books  at  all. 

b.  If  a  discount  is  in  excess  of  the  usual  terms,  as  2/10, 
n/30,  a  trade  discount  is  assumed. 

c.  If  trade  discounts  are  shown  upon  a  set  of  books,  they 
are  deductions  from  purchases  or  sales. 

2.  Cash  discounts,  ^'allowances  not  in  excess  of  a  rate  that 
a  business  could  afford  to  pay  for  the  use  of  money  for  the 
credit  period,"  are  not  treated  uniformly  by  accountants: 

a.  Cash  discounts  on  purchases: 

i.  If  considered  as  a  reduction  in  the  price  of  goods 

they  are  deducted  from  purchases, 
ii.  If  considered  as  concerned  with  the  financing  side 
of  a  business,  they  are  non-operating  profit     This 
latter  view  seems  to  be  the  better  of  the  two. 

b.  Cash  discounts  on  sales: 

If  considered  as  an  overstatement  of  sales,  they  are 
deducted  from  the  sales. 

If  considered  as  a  bait  offered  possible  customers, 
they  are  booked  as  selling  expenses. 
If  considered  as  a  fine  incurred  on  account  of  bad 
financing,  or  as  made  up  of  the  two  elements  of 
mterest  and  bad  debts,  they  are  non-operating  ex- 
penses.   This  last  view  seems  to  be  the  correct  one 
3.  Reserves  for  cash  discounts  on  purchases  and  on  sales   to 
cover  prospective  discounts  that  may  be  taken,  are  advo- 
cated by  some  accountants.    However,  it  would  seem  that 
settrT  "r  ^'T"'  *"  ""^^  distinctions  that  are  alto- 
as  where  they  sum  up  to  a  considerable  amount  • 

'■  fncTsh  ^7  ^''^r  ^''''°"°*^  '^  deducted,'on  the  Bal- 
ance Sheet,  from  the  Accounts  Payable. 


1. 


II. 


111. 


56 


ADVANCED  ACCOUNTING 


b.  Reserve  for  Sales  Discounts  is  deductefi,  on  the  Balance 
Sheet,  from  the  Accounts  Receivable. 
Turnover.— Turnover  may  be  considered  as  the  number  of 
times  a  stock  of  goods  has  been  turned  within  a  specified  period 
of  time.  This  number  of  times  is  determined  by  dividing  the  co^t 
of  sales  by  the  average  amount  of  the  inventory  on  hand  durmg 
the  period  under  review.  The  greater  the  turnover,  the  less 
need  be  the  percentage  of  profit  to  earn  a  definite  fixed  amoiirit- 

of  profit  a  year. 

Insurance.— The  subject  of  insurance  contains  a  number  of 
points  or  principles  that  seem  important  enough  to  require  at 
least  a  complete  chapter.  But  for  present  purposes,  the  dis- 
cussion must  be  curtailed  to  a  marked  degree,  and  only  cer- 
tain general  principles  be  given.  Some  of  these  have  been  covered 
in  a  more  or  less  detailed  manner  in  the  work  of  the  first  year, 
provided  that  such  work  represents  a  course  in  accounting  rather 
than  a  course  in  bookkeeping  which  so  often  is  presented  under 
the  guise  of  an  accounting  title. 

1.  Policy  Register.    This  record  should  prove  valuable  where 
a  number  of  policies  are  in  force  so  that  a  glance  at  any 
one  page  will  take  in  a  number  of  significant  facts. 
a.  The  ruling  for  such  a  register  should  provide  for  tabulat- 
ing the  following  basic  information: 


Policy  numbers. 
Names     of     insurance 

companies. 
Premiums. 
Policy  dates. 


Agencies  used. 
Expiration  dates. 
Nature  of  contract. 
Amount  of  insurance. 
Monthly  premium  distribution. 


2.  Unexpired  premiums.  These  represent  deferred  charges  to 
operation  to  the  extent  of  the  unexpired  portions.  The 
expired  portions  are  written  off  periodically  as  an  expense. 
Expired  insurance  on  a  factory  is  an  item  of  overhead,  and 
expired  insurance  on  manufactured  product  is  a  selling 
expense.  Two  questions  arise  as  to  the  handling  of  the 
unexpired  premiums: 

a.  In  case  of  fire.  The  unexpired  premium,  counting  from 
the  date  of  the  fire,  is  not  recoverable  from  the  insurance 
company ;  therefore,  this  amount  should  be  written  ofi\ 


SPECIFIC  HEAL  AND  NOMINAL  ACCOUNTS  57 

This  may  be  accomplished  by  writing  into  the  Fire  Loss 
account  such  an  amount  as  represents  the  "ratio  of  the 
amount  of  settlement  on  the  part  of  the  insurance  com- 
pany to  the  face  of  the  policy." 
b.  In  case  of  cancellation  of  a  policy.    A  certain  amount  of 
the  premium  paid  will  be  returned  by  the  company,  but 
this  amount  will  not  be  upon  a  pro  rata  basis.     The 
premium  will  be  recalculated  on  the  basis  of  the  length  of 
the  period  during  which  it  was  in  force,  upon  what  is 
known   as   a   "short  rate"   basis.     Then   the   difference 
between    the    original    premium    and    the    recalculated 
amount  will  represent  the  portion  of  the  premium  that 
will  be  returned. 

Co-Insurance  and  Fire  Loss.-Many  fire  insurance  policies 
carry  what  is  known  as  the  "average"  or  "80  per  cent  co-insur- 
ance clause.  Such  a  policy  makes  the  insured  a  co-insurer  with 
the  insurance  company  for  the  difference  between  80  per  cent 
of  the  property's  cash  value  and  the  face  of  the  policy  Where 
such  a  clause  is  in  force,  the  amount  that  may  be  recovered  from 
the  insurance  company  can  be  computed  as  follows- 

1.  Multiply  the  face  of  the  policy  amount  by  the  amount  of 
the  loss. 

2.  Dmde  the  product  from  (1)  by  the  product  obtained  by 
multiplying  the  cash  value  of  the  property  by  80 

3.  The  result  secured  by  (2)  above,  represents  the  amount  that 
may  be  recovered. 

When  a  fire  has  taken  place,  a  Fire  Loss  account  should  be 
opened  in  which  should  be  recorded  the  amount  of  the  loss  suf- 
iered.  The  account  would  be  charged  with  the  value  of  the  asset 
or  assets  destroyed,  after  depreciation  thereon  has  been  adjusted 
down  to  the  date  of  the  fire,  and  the  portion  of  the  depreciation 
reserves  applicable  thereto  have  been  closed  into  the  asset  ac- 
counts affected;  it  would  be  charged  further  with  any  expenses 
arising  m  connection  therewith,  and  with  the  unexpired  portion 
of  the  cancelled  insurance.  The  account  would  be  credited  with 
he  allowance  granted  by  the  insurance  company;  further  with 
the  scrap  value  allotted  to  the  ruins.  The  balance  of  the  ac- 
count should  be  closed  into  Surplus 

If  perpetual  inventories  are  not  kept  of  goods  on  hand,  the 


58 


ADVANCED  ACCOUNTING 


I 


amount  of  goods  on  hand  as  of  the  date  of  the  fire  must  be 
calculated  by  the  gross  profit  test.  The  average  gross  profit  for  a 
period  of  years  is  calculated.  Then  beginning  with  the  last  clos- 
ing date,  a  gross  profit  section  of  the  Profit  and  Loss  Statement 
is  prepared  covering  the  period  from  such  last  closing  down  to 
the  date  of  the  fire.  The  average  gross  profit  on  sales  for  this 
period,  or  portion  of  a  period,  is  assumed  to  be  the  same  as  before. 
Hence,  by  working  backward,  to  a  certain  extent,  the  missing 
inventory  may  be  calculated  fairly  readily. 

Miscellaneous  Insurance  Procedures. — Certain  other  prin- 
ciples relating  to  insiu-ance,  not  included  above,  are  summarized 
below: 

i.  Life  insurance.  If  a  concern  is  the  beneficiary  under  a 
straight  life  policy,  it  is  customary  to  capitalize  the  cash 
surrender  value  of  such  policy.  After  three  yearly  pay- 
ments of  premium  have  been  made,  a  cash  surrender  value 
comes  into  existence,  which  may  be  booked  as  an  asset. 
Subsequently,  each  premium  payment  is  recorded  in  two 
portions : 

a.  One  portion  representing  the  increase  in  cash  surrender 
value  is  capitalized. 

b.  One  portion  representing  the  excess  of  the  premium  over 
the  increase  in  cash  surrender  value  is  charged  to  an 
expense  accoimt. 

In  the  event  of  the  death  of  the  insured  and  the  payment  of 
the  policy  by  the  insurance  company,  the  account  carried  with 
the  cash  surrender  value  would  be  closed  and  the  excess  of  such 
payments  over  the  balance  in  that  account  would  be  credited 
to  Surplus  account. 

2.  Liability  insurance.  Premiimis  covering  insurance  against 
employees'  claims  for  damages  due  to  injuries  are  payable  in 
advance;  therefore,  there  will  be  a  certain  portion  of  the 
premium  unexpired  at  the  end  of  each  period.  Again,  at 
such  date,  it  may  be  necessary  to  make  an  adjustment  due 
to  either  a  refund  on  the  part  of  the  insurance  company, 
or  to  the  fact  that  after  the  period's  payroll  is  known,  the 
premium  paid  may  be  found  to  have  been  insufiicient. 

3.  Bonding  employees.  Premiums  paid  for  this  purpose  usu- 
ally are  charged  out  as  administrative  expenses. 


SPECIFIC  REAL  AND  NOMINAL  ACCOUNTS  59 

4.  Burglary  insurance.  The  premiums  paid  for  this  protec- 
tion usually  are  charged  off  at  once  as  expenses.  The  dis- 
tribution of  such  expenses  depends  upon  the  kind  of  prop- 
erty protected. 

5.  Marine  insurance.  This  point  is  not  of  usual  importance 
but  IS  covered  briefly  in  that  many  C.  P.  A.  examinations 
have  at  least  one  question  bearing  thereon.  If  the  master 
of  a  vessel  in  time  of  distress  jettisons  a  portion  of  the 
property  m  order  to  save  the  vessel  and  the  retained  por- 
tion of  the  cargo  and  freight,  the  loss  suffered  must  be 
borne  upon  a  proportional  basis.  Tlie  above  probably  is 
the  point  of  most  importance  to  an  accountant. 


1 


CHAPTER  III 

PARTNERSHIPS,   VENTURES,    CONTRACTS, 
MANUFACTURING  CONTROL 

Introduction.— Four  major  topics  are  discussed  in  the  present 
chapter.  For  the  most  part,  it  has  been  assumed  that  a  con- 
siderable portion  of  the  work  of  the  first  year  was  devoted  to 
a  detailed  consideration  of  these  subjects  Therefore,  the  cur- 
rent presentation  acts  both  as  a  review  and  as  an  approach  to 
the  work  of  the  subsequent  chapters,  most  of  which  concerns 

corporations. 

Partnership  Formation.— The  legal  organization  of  a  busi- 
ness is  the  organization  unit  which  holds  property  values  and 
directs  their  use  so  that  they  will  dovetail  harmoniously  with  the 
efforts  of  persons.  This  organization  unit  may  take  one  of  three 
forms : 

1.  Sole  proprietorship. 

2.  Partnership. 

3.  Corporation. 

On  the  other  hand,  the  working  organization  of  a  Dusiness  is 
concerned  with  the  internal  activities  thereof  regardless  of  its 
legal  form  of  organization.  A  study  of  partnerships  necessarily 
must  resolve  itself  into  a  consideration  of  both  phases  of  partner- 
ship organization.  But  in  the  present  instance,  since  it  is  assumed 
the  student  is  somewhat  familiar  with  both  these  angles,  from 
his  past  work,  the  principles  presented  have  been  condensed  as 
much  as  seems  possible  consistent  with  reason. 

Partnership  Defined.— "A  partnership,  as  between  the  muH'- 
bers  thereof,  is  the  association,  not  incorporated,  of  two  or  more 
persons  who  have  agreed  to  combine  their  labor,  property  and 
skill  or  some  of  them  for  the  purpose  of  engaging  in  any  lawful 
trade  or  business,  and  sharing  the  profits  and  losses  as  such 

between  them." 

Definite  rules  to  determine  when,  and  when  not,  a  partnership 

60 


PARTNERSHIPS,  VENTURES,  CONTRACTS,  ETC.  61 

is  in  existence  under  any  given  set  of  facts,  cannot  be  given  since 
each  case  arising  must  be  judged  upon  its  own  merits,— the  facts 
existing  thereunder.  In  general,  however,  the  two  following  legal 
principles  are  made  use  of  : 

1.  Are  all  the  elements  present  which  are  essential  to  the  for- 
mation of  a  legally  binding  contract? 

2.  Was  there  an  intention,  on  the  part  of  all  parties  concerned 
to  form  a  partnership?  ' 

If  so,  it  would  seem  that  the  preponderance  of  opinion  states  a 
partnership  to  be  in  existence. 

Partnership,  Advantages  and  Disadvantages.-The  reasons 
or  advantages  in  favor  of  the  partnership  form  of  organization' 
as  opposed  to  that  of  the  sole  tradership,  may  be  set  out  as  under- 

1.  To  secure  additional  capital. 

2.  To  enlarge  the  scope  of  the  business. 

3.  To  secure  the  services  of  another,  because  of  : 

a.  Ability,  or 

b.  Business  connections. 

4.  To  secure  a  subdivision  of  duties,  so  that  specialization  in 
one  particular  direction  may  result. 

The  disadvantages  existing  against  the  formation  of  a  partner- 
ship may  be  summarized  as  follows: 

1.  Unlimited  liability.  In  general,  each  partner  is  liable  beyond 
his  partnership  investment  to  the  extent  of  his  whole  ner- 
sonal  fortune.  ^ 

2.  Friction.  Partners  are  most  apt  to  find  it  difficult  to  get 
along  harmoniously  with  each  other 

3.  Deferred  action.  Since  each  partner,  in  general,  has  as  much 
Ltir  Jrr°^^"°'"*'  "^  '^"^  ""^^'^  Partner,  decisions 
LadeS  a"     """^  "'  """"  '''  ^^^  *°  ^^  "^^'^  ^l-'^"' 

The  disadvantage  of  partnership  liability  is  exceedingly  im- 
portant, except  as  concerns  the  limited  partner  who  jeopard  z" 
Lt    r  'T*""'"*  ^"'  "'^''  '^  ^P-'fi«  -^  his  actions  Tgive  the 

^'  fnrtrf  7'  ^""^  ^  '"''*y  f"'  ^^«'>  °ther  partner,  is  liable 
for  the  full  amount  of  the  firm's  debts.  This  means  tha' 
h.s  private  estate  may  be  attached  for  such  p^^L     Of 


62 


ADVANCED  ACCOUNTING 

course,  in  such  event,  he  would  be  entitled  to  proportionate 
contribution  from  the  other  partners  but,  even  so,  the  mere 
right  to  contribution  does  not  mean  neeessarilv  thai  he  can 
enforce  such  right;  the  others  may  have  dissipated  their 
private  fortunes  prior  to  such  attachment. 

2.  Incoming  partners  may  be  held  liable  for  the  debts  of  the 
old  firm  unless  they  serve  notice  specifically  that  they  will 

not  be  so  held. 

3.  Retiring  partners  are  held  liable  for  the  debts  of  the  firm, 
both  due  and  not  due,  as  of  the  date  of  retirement  rc^gardk^sa 
of  what  might  be  the  actions  of  the  vendees  in  this  respect, 
unless  the  creditors  specifically  agree  to  look  to  such  vendees 

for  payment. 

4.  Naturally,  the  remaining  or  continuing  partners  arc  jointly 

liable  with  those  who  are  retiring. 
Classification    of    Partners     and     Partnerships.-Persons 
forming  a  partnership  must  be  competent  under  the  law  to  con- 
tract (exclusive  of  corporations  unless  so  authorized  specifically 
in  the  charter) .    Competent  persons  are : 

1.  Minors    (since  their   contracts   arc   not  void,   but   merely 

voidable') . 

2.  Adults. 

3.  Partnerships. 

4.  Corporations,  if  expressly  authorized. 
Partners  may  be  classified  as  follows: 

1.  General  (active).  These  take  an  active  part  in  the  firm 
management. 

2.  Limited  (special).  These  have  less  than  full  participation 
in  firm  liability.  The  statutes  must  be  complied  with 
strictly,  because  the  limited  liability  is  in  derogation  of  the 
common  law  liability. 

3.  Dormant  (sleeping).  These  have  no  part  in  the  firm  man- 
agement, and  their  connection  is  a  secret  one.  They  are 
both  secret  and  silent. 

4.  Silent.  These  have  no  voice  in  the  firm  management,  and 
they  may  or  may  not  be  dormant  partners. 

5.  Nominal.  Those  who  are  held  out  to  the  world  as  partners, 
t)ut  who,  in  reality,  are  partners  in  name  only;  these  may 


PARTNERSHIPS,  VENTURES,  CONTRACTS,  ETC.  63 

be  held  legally  as  regular  partners  by  creditors  who  have 
granted  credit  to  the  firm  on  the  strength  of  their  connection. 

6.  Ostensible  (real  or  public).  Those  who  hold  themselves  out 
to  the  public  and  are  known,  therefore,  as  partners,  and 
who,  in  reality,  are  such. 

7.  Secret.  These  partners  are  not  known  as  partners,  although 
they  may  be  engaged  actively  in  the  business. 

8.  Sub-partner.  An  outsider  who  shares  in  the  firm  interest 
of  a  regular  partner.  He  is  not  a  member  of  the  original 
firm  and  is  not  liable  to  its  creditors. 

Partnerships  may  be  divided  as  follows: 

1.  General.  In  these,  all  the  partners  are  tenants  in  common, 
for  the  continued  prosecution  of  a  general  line  of  business.' 
They  are  of  two  basic  kinds: 

a.  Trading.    These  are  formed  to  buy,  sell,  and  manufac- 
ture. 

b.  Non-trading.     These  are  found  among  brokers,  profes- 
sional men— lawyers,  accountants,  etc. 

2.  Special.  These  partnerships  are  formed  to  carry  out  some 
one  line  of  endeavor,  or  to  transact  one  single  piece  of  busi- 
ness; a  joint  venture  is  included  hereunder. 

3.  Limited.  These  partnerships  are  composed  of  two  classes 
of  partners: 

a.  General.    Those  liable  for  the  whole  of  the  firm  debts 
as  in  a  general  partnership. 

b.  Special.    Those  liable  only  for  a  limited  amount  of  the 
firm  debts,  usually  in  the  amount  of  their  investments. 

4.  Joint  stock  company.  This  is  a  partnership  in  which  the 
capital  IS  divided  into  shares  which  are  transferable  with- 
out the  express  consent  of  all  the  partners.  Usually,  it  has 
a  corporate  name,  and  is  governed  by  directors.  A  trans- 
fer of  interest,  war,  and  death  or  bankruptcy  of  its  members 
will  not  necessarily  terminate  its  existence.  It  is  created 
by  contract,  and  the  law  of  the  particular  state  in  which  it 
IS  domiciled  must  be  followed  strictly  in  its  formation. 

vi^'"''''?''!   ^^    P^^^^^^^hiP    Agreement.-The   usual   pro- 

mTnv'bu^tt  t T '•''  '"""'  ^"  ""  partnership  agreement  are 
many,  but  the  following  points,  at  least,  should  be  covered: 


64 


ADVANCED  ACCOUNTING 


1.  Date  of  commencement,  tenn  of  existence,  and  conditions 

of  termination  prior  to  agreed-upon  date. 

2.  Name  of  partnership  and  of  each  partner. 

3.  Nature  and  location  of  business. 

4.  Amount  and  form  of  partners'  contributions,  and  valuation 
of  investments  other  than  cash. 

5.  Rights,  duties,  and  powers  of  partners, 

6.  Personal  drawings. 

7.  Interest  on  personal  drawings  and  capital 

8.  Salaries. 

9.  Distribution  of  profits  and  losses. 

10.  Books  of  account,  and  audit  thereof. 

11.  Arbitration  of  disputes. 

12.  Life  insurance  on  firm  members. 

13.  Procedure  upon  dissolution,  including  closing  of  books,  good- 
will valuation,  and  disposal  of  firm  name. 

Rights,  Duties  and  Powers  of  Partners.— Every  general 
partner  is  a  general  agent  of  the  firm  in  the  transaction  of  firm 
business.  His  acts,  however,  are  circumscribed  to  the  extent 
that,  unless  he  has  been  given  specific  authority,  by  virtue  either 
of  having  entire  charge  of  the  administration  of  the  business, 
or  because  the  others,  for  some  reason,  are  incapable  of  acting, 
he  cannot  legally: 

1.  Act  so  that,  thereunder,  the  business  cannot  be  continued 
as  originally  agreed.  He  may  sell  all  the  merchandise,  but 
not  the  business. 

2.  Confess  a  judgment. 

3.  Submit  a  partnership  claim  to  arbitration. 

4.  Dispose  of  the  good -will. 

5.  Make  an  assignment  to  a  creditor  or  trustee. 
Interest— Salaries— Profits   and    Losses:    Court    Rules.— 

Specific  agreements  in  respect  to  the  above  points,  either  written 
or  oral,  will  hold.  But  where  proof  thereof  is  impossible,  the 
Courts  will  apply  the  following  rules: 

1.  As  to  interest  allowances: 

a.  No  interest  is  to  be  allowed  on  investments. 

b.  No  interest  is  to  be  charged  on  withdrawals. 

c.  The  fact  that  interest  is  allowed  on  investments  does 


PARTNERSHIPS,  VENTURES,  CONTRACTS,  ETC.       '  65 

not  mean  that  interest  is  to  be  charged  on  withdrawals; 

the  latter  must  be  covered  specifically  by  agreement. 
d.  Interest  is  to  be  allowed  on  partners'  advances  and  on 

personal  payments  in  behalf  of  the  firm. 
e   The  legal  rate  of  interest  applies,  if  no  other  is  specified. 

2.  As  to  salaries. 

a.  None  are  allowed. 

3.  As  to  profits  and  losses. 

b.  These  are  to  be  shared  equally. 

Opening  Entries.-After  the  partnership  agreement  has  been 
formed,  and  the  amount  of  capital  investment  decided  upon  the 
opening  entries  are  in  order:  ' 

1.  Where  contributions  are  definite  and  fixed: 

A.  Current  Account,  •  ^ 

B.  Current  Account,  «  j 

To — A.  Capital  Account,  |  a 

B.  Capital  Account,  •  u 

To  record  capital  investment  as  agreed. 
Cash  and  Sundry  Assets  (in  detail),  $  ^ 

To— Sundry  Liabilities  (in  detail),  |  . 

A.  Current  Account,  •   j 

B.  Current  Account,  •  J 
To  record  contributions  as  agreed. 

2.  Where  contributions  are  indefinite  and  fluctuating  The 
usual  example  hereunder  is  where  a  partner  agrees  to  con- 
tribute  certam  assets,  as  Accounts  Receivable,  which  he 
guarantees  to  be  worth  the  value  thereon  placed: 

Accounts  Receivable,  «  j 

To— A — Capital  Suspense,  «  j 

To  record  contingent  contribution. 
Cash,  ^ 

To — Accounts  Receivable,  .   j 

To  record  collections. 
A — Capital  Suspense,  «   j 

To— A— Capital,  ^  ^    . 

To  credit  A  with  definite  amount  of 

capital  contributed  or  guaranteed. 
A — Capital  Suspense,  •  j 

To— Accounts  Receivable,  •   j 

To  close.  ^ 

In  admitting  a  partner  into  a  firm  or  business,  the  two  follow- 
mg^^basic  pomts  and  their  differentiations  should  be  borne  in 


66 


ADVANCED  ACCOUNTING 


1.  Purchasing  an  interest  in  a  business:  capital  not  increased 
thereunder.  The  incoming  partner  pays  over  his  contribu- 
tion to  the  other  or  others  who  pocket  the  procee<Js  as 
agreed.  The  possibilities  hereunder  may  be  classified  as 
below;  assume  A  is  in  business  with  a  net  adjusted  capital 
of  $10,000.00,  and  that  B  purchases  a  one-half  interest 
therein: 

a.  If  B  pays  over  to  A  an  amount  ciiual  to  one-half  the 
present  book  value  of  the  business,  or  $5,000.00. 

A.  Capital  Account,  5,000.00 

To — B — Capital  Account,  5 , 00()  00 

b.  If  B  pays  over  to  A  an  amount  equal  to  more  than  one- 
half  the  present  book  value  of  the  business,  say, 
000.00: 

i.  Good-will  not  considered: 


A — Capital  Account, 

To — B — Capital  Account, 


Good-will, 

To — A — Capital  Account, 
A — Capital  Account, 

To — B — Capital  Account, 


6,000.00 

6,000.00 

ii.  Good-will  considered  (existing  in  the  business) : 

4,000.00 

4,000.00 
7,000.00 

7,000.00 

c.  If  B  pays  over  to  A  an  amount  equal  to  less  than  one- 
half  the  present  book  value  of  the  business,  say, 
$3,000.00: 

i.  Good-will  not  considered: 

A— Capital  Account,  5 ,  000 .  00 

To — B — Capital  Account,  5 ,  (kK)  .  00 

ii.  Good-will  considered  (brought  into  the  busii^Rs— 
same  amount  as  above) : 

Good-will, 

A — Capital  Account, 

To — B — Capital  Account,  7 ,  000 .  00 

2.  Making  an  investment  to  secure  an  interest  in  a  business: 
Capital  increased  thereunder.  The  incoming  partner  pays 
over  his  contribution  to  the  business  fund  as  agreed.  The 
possibilities  hereunder  may  be  classified  as  below;  assume 
the  same  facts  as  in  (1)  above,— that  A  is  in  business  with 


4,000.00 
3,000.00 


PARTNERSHIPS,  VENTURES,  CONTRACTS,  ETC.  g/ 

a  net  adjusted  capital  of  $10,000.00,  and  that  B  makes  an 
mvestment  to  secure  a  one-half  interest  therein- 

a.  If  B  invests  an  amount  equal  to  the  present  book  value 
ot  the  busmess,  or  $10,000.00: 

^Tn     n    n      .^  .  10,000.00 

To— B-Capital  Account,  10  000  00 

b.  If  B  invests  an  amount  equal  to  more  than  the  present 
Dook  value  of  the  business,  say,  $12,000.00: 

i.  Good-will  not  considered: 

^^^       ,     ^     .  12,000.00 

To-A-Cap.tal,  ,^^^ 

B— Capital,  11,000  00 

ii.  Good-will  considered  (existing  in  the  business) : 

S^^^r"'  2,000.00 

Cash  '^'*'''  2.000.00 

T       n     n  .  12,000.00 

.    Tf  T.    •       ^r  P       '  12.000.00 

c.  If  B  mvests  an  amount  equal  to  less  than  the  present 
book  value  of  the  business,  say,  $8,000.00: 
1.  Good-will  not  considered. 

A^'p     .  ,  ,  8,000.00 

A-Cap.tal  Account,  1 ,  000 .  00 

T^B-Capital  Account,  g^oOO.OO 

11.  Good-will  considered  (brought  into  the  business- 
same  amount  as  above) : 

r^^'     n  8,000.00 

^^t       k     n     ■  2,000.00 

Ifin.f.n^     f    To-B-Cap,tal  Account,  io,ooo.OO 

it,  mstead  of  an  agreement  in  accord  with  one  of  the  possibili 

chases  an  interest  m  the  profits  of  a  business,  the  only  adjust 
ment  necessary  when  the  contribution  in  cash  or  other  ass^^^^^ 
the  i'r  """t  "  '^  '^^^  *^^  '^'^'^  ^^-  receiveTand  gt 

?.  p:rricr ' "-'"'  -^'^ " "» '"'^- 

Cash  or  other  assets  (in  detail).  .  , 

To-B-Capital,  *  * 

th  JSistribuZ'of^'i'  not  necessarily  any  connection'between 
ments  "      ^''"^''  """^  '^'  ^""""'^t  °f  the  capital  invest- 


68 


ADVANCED  ACCOUNTING 


Partnership  Operation.— The  operation  of  a  partnership, 
from  the  standpoint  of  record  making,  differs  in  no  way  from 
a  sole  proprietorship  or  even  from  a  corporation.  In  other  words, 
the  principles  followed  in  the  recording  of  current  transactions 
are  similar  in  each  of  the  three  basic  types  of  legal  organization ; 
the  only  differences  encountered  are  due  to  the  size  of  the  con- 
cern in  question  and  to  the  intelligence  and  efficiency  of  its  man- 
agement,—not  at  all  due  to  the  legal  form  thereof. 

Because  of  the  above,  it  is  unnecessary  herein  to  comment 
upon  partnership  work,  as  to  operating  periods,  until  one  reaches 
the  time  where  a  closing  of  the  books  is  in  order.  Then  certain 
specific  principles  must  be  known,  peculiar  to  partnership  work, 
in  order  that  such  closing  may  be  made  in  a  correct  manner. 

Partnership  Profits. — The  first  point  relative  to  partnership 
closing,  a  simple  one,  concerns  the  distribution  of  th(i  net  profit 
of  the  period,  after  the  latter  has  been  calculated  in  the  usual 
manner,  except  for  salaries.  Partners'  salaries  are  not  operating 
expenses,  being  considered  as  a  distribution  of  profits.  In  other 
words,  the  net  profit  for  the  period  should  be  calculated  without 
reference  to  salaries  of  partners.  Then  the  salary  adjustments 
would  be  made,  following  which  the  remaining  amount  of  the 
net  profit,  or  the  resulting  net  loss,  should  be  distributed;  such 
distribution  may  be  made : 

1.  Direct  to  capital  accounts,  or 

2.  To  the  personal  accounts,  after  which  these  are  closed 
into  the  capital  accounts. 

Undrawn  salaries  are  not  current  liabilities;  in  the  Balance 
Sheet,  they  should  be  allocated  under  the  proprietorship  section. 
Profits  may  be  distributed  in  any  one  of  a  number  of  ways: 
1.  If  agreement  is  silent  in  respect  thereto: 

a.  The  profits  will  be  shared  equally;  likewise,  the  losses 
would  be  shared  in  the  same  proportions. 
2.  If  agreement  covers  the  case: 

a.  On  the  basis  of  the  capital  originally  contributed.  In 
this  event,  care  must  be  observed  to  determine  what  were 
the  original  contributions.  To  this  end,  it  may  be  ad- 
visable to  have  the  original  contributions  carried  in  sepa- 
rate accounts,  and  all  accretions  thereto  or  reductions 
therein  carried,  also,  in  separate  accounts. 


PARTNERSHIPS,  VENTURES,  CONTRACTS,  ETC. 

b.  On  the  basis  of  the  capital  originally  contributed  and 
accumulated— net  investments  existing  at  the  time  the 
profits  are  divided,  i.  e.,  at  the  end  of  the  period,  capital 
accounts  plus  personal  accounts. 

c.  On  the  basis  of  capital  contributed  and  time  employed  — 
average  investments.  The  method  of  calculation's 
arithmetical  in  every  particular,  and  this  follows  a  two- 
way  possibility: 

i.  Day-basis.  This  is  usable  where  the  investments 
and  withdrawals  have  not  been  made  on  the  first 
day  of  the  month. 

(a)  Multiply  separately  for  each  partner  each  in- 
vestment and  withdrawal  by  the  number  of 
days  elapsing  between  the  date  of  the  trans- 
action and  the  closing  date  of  the  period.  The 
difference  between  the  day-dollars  for  the  in- 
vestments and  for  the  withdrawals  represents 
the  average  investment  for  the  period  for  each 
partner. 

(b)  Follow  the  same  procedure  as  above  except 
that  the  multiplication  is  on  the  basis  of  net 
mvestments  and  the  number  of  days  each  net 
investment  remains  unchanged. 

ii.  Month  basis.  This  is  usable  where  the  investments 
and  withdrawals  have  been  made  on  the  first  day 
of  the  month. 

(a)  Qualified  by  the  month  basis,  proceed  as 
indicated  above  for  i-(a). 

(b)  Qualified  by  the  month  basis,  proceed  as  indi- 
cated above  for  i-(b). 

d.  On  a  basis  which  bears  no  relation  to  investment.  Part- 
ners may  agree  to  share  profits  in  any  proportion  regard- 
less of  the  amounts  of  capital  contributed  to  the  busi- 
ness This  method  is  used  frequently  to  adjust  inequali- 
^es  between  partners,  as  where  one  partner  has  a  pecu- 
liar training  and  skill  which  is  highly  desirable  in  the 
quest  for  success,  or  where  one  partner  devotes  more  time 
to  the  business  than  the  other  or  others.  It  is  possible 
because  of  one  of  the  above  reasons,  to  find  a'pTrlne; 


70 


ADVANCED  ACCOUNTING 


n 


!i 


sharing  in  the  profits  without  having  made  any  invest- 
ment at  all  either  in  cash  or  in  properties. 
Interest  on  Capital  Contributions. — ('harging  interest  on 
partners'  investments  and  withdrawals  would  be  in  order  under 
every  condition  except  where  profits  are  shared  in  proportion 
to  investments,-:-when  the  profit  sharing  ratios  and  the  capital 
ratios  are  alike, — and  all  partners  draw  equally  and  at  the  same 
time.  When  interest  is  not  allowed  on  i)artners'  capital,  the 
following  results: 

1.  If  the  investment  or  capital  ratios  are  equal,  and  the  profit 
or  capital  ratios  unequal,  the  partner  with  the  larger  ratio 
of  profits  loses. 

2.  If  the  profit  sharing  ratios  are  equal,  and  the  investment 
or  capital  ratios  unequal,  the  partner  with  the  smaller  ratio 
of  capital  loses. 

3.  If  the  investment  or  capital  ratios  are  unequal,  and  the 
profit  sharing  ratios  are  unequal,  the  result  depends  upon 
the  proportion  in  which  the  profits  are  shared  and  the  re- 
spective investments  of  each  partner. 

Interest  adjustments  are  handled  usually  through  the  Profit 
and  Loss  Account  after  the  operating  net  profit  has  been  cal- 
culated. The  resulting  credit  or  debit  balance  then  remaining 
is  distributed  to  the  partners  in  their  profit  sharing  or  loss  shar- 
ing ratios.  Such  interest  adjustments,  not  being  business  ex- 
penses, should  be  made  just  prior  to  the  eventual  distribution  of 
the  surplus  net  profit,  or  net  loss.  Such  interest,  in  other  words, 
represents  profit  allocation.  Of  course,  tiie  partnership  agree- 
ment may  specify  that  such  interest  be  booked  as  an  expense 
and,  in  this  event,  such  manner  of  recording  would  be  in  order. 
At  times,  the  adjustment  of  interest  is  made  directly  in  the  draw- 
ing or  personal  accounts,  first  charging  them  with  the  amount 
and  then  crediting  them  with  the  distribution  thereof. 

The  arithmetical  calculation  of  interest  charges  and  credits 
is  a  simple  matter,  as  a  rule,  as  when  allowed  on: 

1.  Net  investment,  or 

2.  Original  investment. 

However,  when  calculated  on  the  average  investment,  care 
must  be  observed  in  arriving  at  the  proper  averages  upon  which 
the  computations  are  made.    The  principles  mentioned  above  in 


PARTNERSHIPS,   VENTURES,  CONTRACTS,  ETC.  n 

the  last  section,  covering  the  distribution  of  profits  on  the  basis 
of  capital  contributed  and  time  employed,  should  be  borne  in 
mind. 

Where  partners  have  agreed  to  furnish  a  certain  amount  of 
capital  and  one  or  more  has  not  fulfilled  such  agreement    and 
where  mterest  is  to  be  considered  on  the  excess  or  defic'it  of 
capital,  three  methods  of  adjustment  would  seem  in  order: 
1.  Consider  the  respective  excesses  or  deficits  on  capital  con- 
tributed.   Charge  interest  against  partners  with  deficiencies 
and  credit  interest  to  partners  with  excesses,  offsetting  by 
credits  and  charges  to  Profit  and  Loss  account.    Then  dis- 
tribute  the  resulting  balance  amount  according  to  the  in- 
terest each  partner  has  in  the  firm's  profits  or  losses 

2.  Consider  the  whole  capital  actually  contributed  by  each 
partner  and  then  credit  each  one  for  the  interest  thereon 
charging  Profit  and  Loss  account.     Distribute  the  total 
Profit  charge  according  to  the  interest  each  partner  has 
in  the  firm's  profits  or  losses. 

3.  Determine  the  ratios  of  the  agreed  capitals,  one  to  the 
other.  Then  on  the  basis  of  preserving  the  same  ratios  of 
mterest  as  regards  the  actual  contributions,  calculate  the 
adjustment  of  the  interest.  Those  who  have  contributed 
m  excess  of  the  established  ratios  are  assumed  as  having 

oaned  such  excess  amounts  to  those  who  have  contributed 
less  than  prescribed  by  the  established  ratios.  In  this  case 
the  interest  adjustment  would  be  between  capital  accounts' 
entirely,  the  credits  in  favor  of  those  with  the  excess 
amounts  being  calculated  upon  such  excess  amounts,  and 
these  credits  being  offset  by  charges  against  those  with  de- 
ficiencies the  calculations  being  upon  the  deficient  amounts 
The  debits  and  credits  will  offset  each  other 

for  o'nrnr'''''  ^^^^^^"*r-^  partnership  may  be  dissolved 
for  one  of  many  reasons,  the  dissolution  being  either  voluntarv 

oltZZl:\'''  '^'"'''''^  ^^  involunta^,^again:;r:?;i: 
out  tne  consent  of  one  or  more  of  them- 

1.  Expiration  of  term  of  partnership  agreement. 
^.  Mutual  agreement. 

3.  Partnership  object  becoming  illegal  or  impossible. 
4-  bale  or  assignment  of  a  partner's  interest 


72 


ADVANCED  ACCOUNTING 


11 


>  • 


5.  Admission  of  a  partner. 

6.  Bankruptcy  of  the  firm. 

7.  Withdrawal  of  a  partner. 

8.  Sale  or  transfer  of  a  firm  to  another. 

9.  Death  of  a  partner. 

10.  Insanity,  bankruptcy,  misconduct,  or  disability  of  a  part- 
ner. 

11.  War  between  nations  represented  by  the  partners. 

Asset  Application  Upon  Dissolution.— Under  partnership 
law,  upon  dissolution,  the  assets  are  applied  as  folows: 

1.  Firm  debts  to  outside  creditors. 

2.  Advances  or  loans  made  by  partners. 

3.  Return  of  capital,  as  per  capital  accounts. 

4.  Return  of  profit  residue,  if  any,  among  the  partners  in 
the  profit  and  loss  sharing  ratio. 

If  a  loss  is  suffered  in  the  dissolution  process,  the  loss  must  bo 
distributed  at  the  point  of  No.  3,  above,  following  which  the  capi- 
tal will  be  returned.  Again,  if  the  loss  in  the  dissolution  is  so 
great  that  thereby  the  capital  of  one  or  more  partners  is  wiped 
out  and  a  deficit  replaces  it,  a  transfer  should  be  made  from 
the  loan  account  of  such  partner,  before  the  loan  account  is 
liquidated  by  the  return  of  assets,  so  that  such  deficit  will  be 
cancelled. 

In  winding  up  the  affairs  of  a  partnership,  regardless  of  cause, 
it  would  seem  that  the  following  points  or  principles  are  of  im- 
portance. Some  of  them  should  have  been  incorporated  into  the 
articles  of  agreement,  but,  even  if  not  so  done,  it  would  seem 
advisable  to  consent,  where  necessary,  to  their  use: 

1.  In  case  of  a  partner's  death,  the  interest  that  the  estate 
of  the  latter  may  have  therein,  as  to  profits,  would  be  for 
the  portion  of  the  current  period  up  to  the  date  of  death. 
Provision  should  be  made  for  continuing  the  business  for  a 
certain  time  so  as  to  realize  as  much  cash  as  possible  to  pay 
over  to  such  estate,  or  provision  should  be  made  for  buy- 
ing out  the  interest  of  the  deceased  partner  and  paying  for 
this,  periodically,  over  a  period  of  time.  Likewise,  from 
date  of  death  to  the  date  of  final  settlement  it  is  customary 
to  allow  interest  upon  the  deceased  partner's  share  in  the 
business.    Again,  if  the  firm  has  a  certain  amount  of  good- 


PARTNERSHIPS,  VENTURES,  CONTRACTS,  ETC.  73 

Will,  the  estate  of  the  deceased  partner  should  receive  some 
allowance  for  the  share  of  the  deceased  partner  therein 
2.  Upon  dissolution,  by  retirement  or  death,  great  care  should 
be  observed  m  placing  a  value  upon  the  firm  assets,  so  that 
the  mterest  of  the  retiring  partner  or  the  estate  of  the  de- 
ceased partner  will  not  suffer.    The  usual  rule  would  be  to 
value  at  reproduction  cost,  less  depreciation  to  date  of  dis- 
solution, regardless  of  book  valuations.     The  depreciation 
reserves  should  be  written  off  against  the  assets  affected, 
but  surplus  reserves  should  be  considered  as  part  of  net 
worth.     Further,  if  notice  of  dissolution  be  not  given  to 
firm  creditors,  a  retiring  partner  will  continue  to  be  liable 
for  new  obligations. 
3.  One  or  more  of  the  surviving  partners  usually  is  appointed 
to  take  charge  of  the  liquidations;  even  though,  theoreti- 
cally, all  partners  have  an  equal  voice  and  share  in  such 
Tvork.    Notice  must  be  given  to  all  persons  dealing  with 
the  firm  that  the  partnership  is  being  dissolved,  and  who 
IS  winding  up  affairs;  this  may  be  through  the  local  news- 
paper.   Further: 

a.  Existing  contracts  must  be  fulfilled. 

^'  issibir^^'  '"'''^  ^^  ^''^'^"^  ""^  ^'  advantageously  as 

c.  Debts  and  obligations  must  be  discharged 

d.  New  contracts  cannot  be  made  unless  necessary  in  con- 
nection with  realizing  upon  the  assets 

^'  cJT'^^'  "^^  compensation,  in  the  way  of  salary  or 

Terr'  '"^^'  ''"^"'^'  '^  ^^^  ^^^-^^^^^  -less 
agreed  to,  m  which  event  the  following  may  result- 

I.  The  amount  may  be  adjusted  privately  between 
the  partners. 

ii.  The  amount  may  be  paid  by  representatives  of  the 

deceased  partner. 

iii.  The  amount  may  be  charged  up  as  part  of  the 

''qu'dation;  this  is  to  be  preferred. 

■       nerZlu"^  ^T^'f''    ^^'  ^"*^^^«*  ^^  "-  retiring  part- 

comoTetld  .     fl"'/  ""''''"'  ^'^""'^  '°  contracts  un- 

Z  on;   1?:  ''"^  ""^  ""'^^'^''^^  -^  ^  -determined 


i 

A 

V 

4* 


t 

i' 


I 


» 


74  .4Df.4A'C£;d  accounting 

a.  They  may  be  valued  as  of  dissolution  date  at  market 
price,  and  the  estimated  profit  resulting  from  this  basis 
of  valuation  distributed. 

b.  The  books  may  be  kept  open  until  the  contracts  are 
completed,  after  which  the  regular  realization  would  be 
in  order. 

5.  Sharing  liquidation  losses.  Liquidation  losses,  and  for  that 
matter,  liquidation  profits,  may  be  allocated  to  the  various 
partners : 

a.  In  the  capital  ratios,  or 

b.  In  the  profit  and  loss  sharing  ratios.  This  would  seem 
to  be  the  more  correct  method  of  the  two. 

6.  Instalment  distribution;  liquidation  dividends.  The  prin- 
ciple herein  involved  is  exceedingly  important  in  that  since 
the  liquidation  of  a  partnership  is  apt  to  be  spread  over  a 
considerable  period  of  time,  the  partners  may  wish  to  re- 
ceive by  instalments  from  time  to  time  what  is  coming  to 
them  rather  than  wait  until  everything  is  finally  wound  up, 
and  the  liquidator  must  protect  himself  from  overpaying  a 
partner  unless  he  wishes  to  be  personally  responsible  to 
all  who  may  suffer  by  virtue  of  such  overpayment.  Since 
no  one  knows  what  the  ultimate  net  realization  will  be,  the 
liquidating  partner  or  partners  must  proceed  as  if  all  the 
assets  on  hand,  except  cash,  at  any  distribution  date,  are 
worthless.  The  liquidator  would  calculate  the  share  of  each 
partner,  the  amount  to  be  charged  against  each  partner, 
of  the  assumed  worthless  assets  and,  the  partners  whose 
capital  accounts  still  show  a  credit  balance  would  be  the 
only  ones  entitled  to  share  in  the  instalment  to  be  paid. 
The  distribution  of  such  instalment  would  then  be  made  in 
su?h  a  manner  that,  as  quickly  as  possible,  the  capital  ratios 
will  be  reduced  to  the  profit  and  loss  sharing  ratios.  After 
the  capital  accounts  have  been  reduced  to  the  point  that 
their  ratios  equal  the  profit  and  loss  sharing  ratios,  further 
distributions  of  instalments  will  present  no  problem,  being 
made  in  accord  with  the  profit  and  loss  sharing  ratios. 

JOINT  VENTURES  AND  CONTRACTS 

Joint  Venture  Defined. — A  joint  venture  exists  when  two  or 
more  persons  combine  in  contributing  some  capital  and  servicq^ 


PARTNERSHIPS,   VENTURES,  CONTRACTS,  ETC.  75 

on  a  temporary  partnership  basis,  to  participate  in  some  par- 
ticular business  deal  involving  the  buying  and  selling  of  a  single 
article,  the  making  and  selling  of  some  particular  thing,  or  trad- 
ing in  a  particular  lot  of  goods,  and  sharing  the  profits  or  losses 
resulting  therefrom.  A  joint  venture  is  practically  a  partner- 
ship for  a  specific  purpose,  the  members  being  partners  so  far 
as  the  specific  transactions  of  the  venture  are  concerned.  As 
relates  to  these  transactions,  the  laws  of  partnership  apply,— 
as  to  profits,  losses,  salaries,  and  interest  adjustments.  It  is  usual 
for  one  of  the  members  to  the  venture  agreement  to  act  as- 
manager  and  handle  the  greater  portion  of  the  work,  including 
the  record  keeping,  for  which  perhaps  he  receives  a  small  per- 
centage on  the  amounts  handled  to  remunerate  him  for  his  time 
and  trouble. 

Venture  Entries.— Two  basic  methods  exist  for  handling  the 
book  entries  relating  to  a  venture: 

1.  No  separate  set  of  records  is  opened.  Each  venturer,  upon 
his  own  records,  records  the  transactions  he  enters  into  in 
behalf  of  the  venture.  No  joint  bank  account  is  used. 
Eventually,  each  party  renders  a  detailed  statement  of  all 

.  transactions  entered  into  by  him  on  account  of  the  venture. 
The  various  separate  statements  then  would  be  summarized 
into  one  statement,  or  Joint  Venture  account  which,  when 
agreed  to  as  being  correct,  becomes  the  basis  for  settle- 
ment. This  Joint  Venture  account  is  a  Trading  account  in 
which  is  indicated  the  profit  or  loss  from  the  venture.  Upon 
the  results  therein  shown,  each  venturer  will  adjust  his  own 
books  for  his  share  of  the  outcome.  The  balance  shown 
upon  his  books  will  indicate  the  amount  due  to  him  from  the 
others  or  by  him  to  the  others. 

2.  A  separate  set  of  records  is  opened.  Hereunder,  a  joint 
bank  account  is  opened,  and  the  records  are  handled  in  the 
same  manner  as  are  those  of  an  ordinary  partnership.  The 
number  of  accounts  to  be  opened  depends  upon  desirability: 

a.  A  complete  classification  of  accounts  may  be  established. 

b.  An  incomplete  classification  of  accounts  may  be  used,  as: 

i.  A  Capital  or  Investment  account  for  each  venturer. 

ii.  A  Joint  Venture  account,  which  is  charged  or  cred- 
ited whenever  a  Capital  account  is  credited  or 
charged. 


76 


ADVANCED  ACCOUNTING 


t 
•  . 

! 


\\ 


V 


♦ 


Accounts  Related  to  Contracts.— When  a  contract  is  to  be 
the  basis  for  the  making  of  book  entries,  from  the  stanrlpoint  of 
the  contractor,  two  problems  arise: 

1.  The  cost  accounting  necessary  in  connection  therewith. 
This  would  resolve  itself,  primarily,  under  the  division  of 
specific  order  cost  accounting  as  distinguished  from  process 
cost  accounting.  Naturally,  a  complete  discussion  of  this 
problem  must  be  reserved  for  a  course  in  Cost  Accounting, 
except  insofar  as  certain  control  principles  are  reviewed  in 
subsequent  sections  of  the  present  chapter. 

2.  When  the  completion  of  a  contract  covers  more  than  one 
fiscal  period,  the  problem  arises  of  proportioning  the  profit 
as  between  periods. 

a.  Even  though  each  period  is  entitled  to  the  profit  earned 
therein,  the  difficulty  of  estimating  the  profit  accrued  as 
of  any  particular  closing  date,  due  to  the  fact  that  a 
considerable  risk  exists  in  estimating  the  cost  of  com- 
pletion, may  make  it  necessary  or  conservative  to  wait 
until  the  contract  is  completed  before  the  profit  therein 
is  calculated. 

3.  Since  the  delay,  due  to  (2a)  above  may  not  be  acceptable, 
dividends  thereunder  perhaps  being  affected  seriously,  it- 
may  be  necessary  to  estimate  the  profit  thus  far  made  as  of 
a  current  closing  date.  If  so,  the  most  conservative  treat- 
ment would  be  in  order.  The  cost  of  completion  should  be 
estimated  at  a  figure  sufficiently  high  to  cover  all  ordinary 
contingencies.  Then  upon  the  basics  of  the  periodical  esti- 
mated costs,  the  estimated  periodical  profit  may  be  calcu- 
lated by  a  prorating  process. 

Contracts  Upon  the  Balance  Sheet.— The  profit  upon  con- 
tracts preferably  is  considered  as  an  operating  profit,  rather  than 
allocating  the  item  to  some  other  section  of  the  Profit  and  Loss 
account.  If  profit  is  to  be  calculated  upon  uncompleted  con- 
tracts, the  Balance  Sheet  set  out  would  be  about  as  follows: 

Uncompleted  Contracts,  cost  to  date,         $  jf 

Estimated  Profit  Earned  on  Above,  $  |  $0 

Deduct — ^Amounts  Received  on  Account,     "^  $  ^ 

Net  Equity  in  Uncompleted  Contracts,  |  i 


PARTNERSHIPS,  VENTURES,  CONTRACTS,  ETC.  77 

Entries  Upon  Contractor's  Records.— In  view  of  the  fact 
that  m  the  student's  work  up  to  this  time  nothing  has  been  men- 
tioned concerning  contract  accounting,  and,  also,  because  the 
prmciples  mentioned  in  the  above  sections  are  not  all  sufficient, 
the  following  simple  problem,  and  its  solution,  are  given  below. 

Problem.— A  contractor  secures  a  contract  for  $40,000.00,   which   will 
take  about  two  years  to  complete.     The  cost  is  estimated  to  be  $30,000  00 
J  en  per  cent,  is  to  be  retained  by  the  customer  until  the  latter  is  satisfied 
that  the  work  completed  is  not  defective.     The  estimates,  covering  amounts 
to  fall  due  from  time  to  time,  are: 

1.  First  year:  $12,000.00;  $8,000.00-Make  only  one  entry  to  cover 

2.  Second  year:  $14,000.00;  $6,000.00— Make  only  one  entry  to  cover 
Required: 

1.  Entries  on  the  assumption  that  the  contract  price  is  entered  upon 
the  books  when  the  contract  is  signed,  and  that  the  profit  thereon  is 
not  booked  until  the  contract  is  completed. 

2.  Entries,  on  the  assumption  that  the  contract  price  is  entered  upon 
the  books  when  the  contract  is  signed,  that  the  profit  therefrom  is 
applied  to  the  period  in  which  earned,  and  that  the  books  are  closed 
when  the  contract  is  half  completed. 

Solution.--The  entries  presented  below  are  illustrative  only,  in  that 
great  variations  are  found  in  entry  making  of  this  kind.  Usually,  the  first 
^ntry  will  be  to  charge  the  customer  as  soon  as  the  contract  is  awarded. 
Naturally,  no  real  account  receivable  comes  into  being  at  that  point  but 
only  when  a  contract  either  is  completed,  or  when  a  payment  is  due  thereon, 

Xnl  T  r*'"^"^*"  '"  ''''^'''^-  ^^^^'  '"^  *^^  fi^«*  '''^^^^^'  the  credit 
otten  ,s  made  to  an  mcome  account  which  is  adjusted  periodicaUy  as  to  the 

^ZT''l"^!"^  rf '^  ^'  '^^  '^^*^^^*-  However,  no  income  is  earned 
r^nLZ  %  .  "''''^''^.  ^  '°''*'^'*'  '^^'^^'''^'  «"^^  ^""'^y'  theoretically, 
oZ      ?     ■  '*  ''  ""'"^^  ^^'  *^^  customer  to  hold  back  a  portion  of  the 

contract  price  as  a  guarantee  against  defective  work,  this  angle  is  covered 

1  ^' r  Z^^'^'-     ^^'^  ^  ^^^^^^^  ^"^^  ^^y  ^  '^d-  ^t  the  time  each 

lat^fv  ''  T   r  '""  ^t"^^^*^^^  ^ith  the  last  payment  due,  a^uming  such 


First  Assumption 


Second  Assumption 


First  Year 


Upon  Signing  the  Contract 

^""""^/xT^^''"'"^  Contracts  Secured 

To     Un^       ^  .  .  *'''^  ^^«-  1)  ^'000 

To-Uncompleted  To-Uncompleted 

Contracts  (No.  1)  40,000  Contracts  (No.  1)  40  000 


78 


I 


ADVANCED  ACCOUNTING 


For  Costs  of  Contract — 1/2  Assumed 


PARTNERSHIPS,   VENTURES,  CONTRACTS,  ETC. 


79 


Contracts  in  Process 

Contracts  in  Process 

(No.  1) 

15,000 

(No.  1)                   15,000 

To — Accounts  or 

To — Accounts  or 

Vouchers  Payable 

15,000 

Vouchers  Payable             1 5 ,  000 

Upon  Rendering  Estimates 

Accounts  Receivable 

Accounts  Receivable 

(Contracts) 

20,000 

(Contracts)             20,000 

To — Advances  on 

To — Advan<'es  on 

Contracts 

20,000 

Contracts                            20.000 

Uncompleted  Con- 

Uncompleted Con- 

tracts (No.  1) 

20,000 

tracts  (No.  1)         20,000 

To — Contracts 

To — Contracts 

Secured  (No.  1) 

20,000 

Secured  (No.  1)                 20,000 

Upon  Payment  of  Estimates 

Cash 

18,000 

Cash                               18,000 

To — Accounts  Re- 

To— Accounts  Re- 

ceivable (Con- 

ceivable (Con- 

tracts) 

18,000 

tracts)                             18,000 

Amount  billed  less 

Amount  billed  less 

proportion  for  de- 

- 

proportion  for  de- 

fective work  re- 

fective work  re- 

serve 

serve 

No  Entry 

Advances  on  Con- 
tracts                     20,000 
To — Profit  and  Loss 

(No.  1)                             3,000 
Reserve  for  Defec- 
fective  Work 

(No.  1)                              2,000 
Contracts  in  Pro- 
cess (No.  1)                   15,000 

Second  Year 

For  Costs  of  Contract — 1/2  Assumed 

Contracts  m  Process 

(No.  1)  $15,000 

To — Accounts  or 

Vouchers  Payable  1 5 ,  000 


Contracts  in  Process 

(No.  1)  $15,000 

To — Accounts  or 

VoucheiH  Payable  15,000 


Upon  Rendering  Estimates 

Accounts  Receivable  Accounts  Receivable 

(Contracts)  20,000  (Contracts)  20,000 

To — Advances  on  To — ^Advances  on 

Contracts  20,000  Contracts  20,000 


Uncompleted  Con- 
tracts (No.  1) 
To — Contracts  Se- 
cured (No.  1) 

Cash 

To — Accounts  Re- 
ceivable (Con- 
tracts) 
Advances  on  Con- 
tracts 
To — Profit  and  Loss 
(No.  1) 

Reserve  for  De- 
fective Work 
(No.  1) 
Contracts  in  Pro- 
cess (No.  1) 


Uncompleted  Con- 
20,000  tracts  (No.  1) 

To — Contracts  Se- 
20,000  cured  (No.  1) 

Uf)on  Payment  of  Estimates 


20,000 


20,000 


18,000  Cash 

To — ^Accounts  Re- 
ceivable (Con- 
18,000  tracts) 

Advances  on  Con- 
40,000  tracts 

To — Profit  and  Loss 
6,000  (No.  1) 

Reserve  for  De- 
fective Work 
4,000  (No.  1) 

Contracts  in  Pro- 
30,000  cess  (No.  1) 


18,000 


18,000 


20,000 


3,000 


2,000 
15,000 


Upon  Complete  Acceptance  by  Customer  that  Work  O.K. 


Cash  4,000 

To — Accounts  Re- 
ceivable (Con- 
tracts) 4,000 
Reserve  for  Defective 

Work  (No.  1)  4,000 

To — Profit  and  Loss 

(No.  1)  4,000 


Cash  4,000 

To — Accounts  Re- 
ceivable (Con- 
tracts) 4,000 
Reserve  for  Defective 

Work  (No.  1)  4,000 

To — Profit  and  Loss 

(No.  1)  4,000 


Entries  Upon  Records  of  Contract  Customer.— The  con- 
cern which  awards  a  contract  to  a  contractor  may  or  may  not 
book  the  contingent  asset  and  liability  thereunder;  preferably, 
the  booking  should  be  made.  The  simplest  example  of  the 
method  of  making  such  record  is  illustrated  by  the  entries  below 
given  covering  one  portion  of  a  recent  A.  I.  A.  problem. 

Problem. — The  portion  of  the  problem  referred  to  above  reads  about  as 
follows: 

Frame  any  entries  necessary  to  record  the  action  of  the  directors  as  it 

appears  in  the  minutes  of  the  meeting  of  August  15,  1917,  of  which  the 

following  is  a  synopsis,  and  the  action  of  the  officers  taken  pursuant  to 

authority  conferred  on  them  by  such  minutes: The  president 

reported  that  he  had  received  tenders  for. a  new  building  planned  in  the 

amount  of  $185,000.00.     He  was  authorized  to  execute  a  contract  accord- 
ingly. ' 

Solution.— Aa  under  the  date  of  the  contract  executed  in  accord  with  the 
above  authority,  the  entry  might  be  as  follows: 
Construction  Account  185,000.00 

To — Contracts  Payable  185 ,  000 .  00 


80 


ADVANCED  ACCOUNTING 


I 


il 


M 


ti 


The  account  above  credited  is  assumed  as  not  being  a  credit  to  tlie 
contractor,  because  the  actual  liability  to  him  is  not  incurred  until  the 
contract  is  completed  or  until  an  estimate  has  been  received. 

MANUFACTURING:    ACCOUNTS  AND  CONTROL 

Purpose  of  Discussion.— The  material  presented  in  this 
section  is  submitted  for  the  following  purposes  only: 

1.  To  review  certain  definitions  and  simple  principles  of  manu- 
facturing and  general  cost  accounting, 

2.  To  set  out  certain  definitions  and  simple  principles  of  manu- 
facturing and  general  cost  accounting  of  a  general  nature 
but  which,  it  is  hoped,  will  cause  the  student  both  to  recog- 
nize the  existence  of  a  great  specific  accounting  field  of 
study  and  research  relative  to  manufacturing  industries  and 
become  sufficiently  interested  therein  to  devote  a  year  or 
so  of  his  time  to  acquaint  himself  thoroughly  with  some  of 
the  practices  therein  followed.  It  would  seem  that  no  one 
rightly  should  call  himself  an  "accountant"  until  he  has 
familiarized  himself  thoroughly  at  least  with  the  general 
principles  followed  in  industrial  accounting  as  well  as  those 
covered  in  a  theoretical  manner  in  a  general  course  in 
accounting. 

Interest  in  cost  accounting  is  growing  by  leaps  and  boundR^ 
reflecting  the  increased  demand  by  employers  for  accurate  and 
helpful  costs.  Each  industrial  establishment,  having  internal 
organization  problems  and  external  market  relationships,  should 
regard  a  cost  system  as  a  requisite  piece  of  administrative  ma- 
chinery functioning  to  "combine  the  various  factors  of  prorluction 
in  the  most  advantageous  proportions  and  relationships  and  to 
adjust  his  output  to  the  market  so  that  there  will  accrue  (to  the 
enterprise)  a  maximum  net  return." 

Manufacturing  Accounts. — In  a  manufacturing  busine«s  the 
accounts  are  grouped  under  three  main  titles: 

1.  Manufacturing.  These  show  the  cost  of  materials,  labor, 
and  factory  expenses  that  compose : 

a.  Manufacturing  or  factory  cost. 

b.  Cost  of  manufactured  product. 

c.  Cost  of  finished  and  unfinished  product  on  hand. 

d.  Cost  of  manufactured  product  sold. 

When  cost  records  are  kept,  it  is  usual  to  charge  a  Selling 


PARTNERSHIPS,  VENTURES,  CONTRACTS,  ETC.  gl 

account  with  the  cost  of  manufactured  product  sold,  rather  than 
with  the  total  cost  of  manufactured  product  which  usually  is  the 
procedure  followed  when  no  cost  records  are  kept.    In  both  cases 
however,  the  result  is  the  same.  ' ' 

2.  Selling  or  trading.     These  accounts  show: 

a.  Gross  sales. 

b.  Sales  returns  and  allowances. 

c.  Net  sales. 

d.  Cost  of  manufactured  product  sold. 

e.  Gross  profit  on  sales, 
f.  Selling  expenses. 

g.  Net  profit  on  sales. 

3.  Profit  and  loss  or  administrative.  These  accounts  set  out 
the  general  administrative  expenses.  The  total  of  these 
deducted  from  the  net  profit  on  sales  produces  the  net  profit 
on  operations.  And  when  the  expenses  related  to  the  financ- 
ing are  deducted  herefrom,  there  remains  the  net  profit  for 
the  period. 

The  selling  and  administrative  expenses,  as  a  rule,  may  be  esti- 
mated closely  m  advance,  some  enterprises,  as  to  these,  following 
a  budgetary  system  under  which  a  specific  sum  of  money  is  deter 

On  the  other  hand,  the  manufacturing  cost  cannot  well  be  deter- 
mmed  m  advance,  since  its  elements  are  varied,  the  productVon 
hazards  are  great,  and  the  ultimate  results  uncertain 

is  ]^^'iteThl°^  '"°"'''  ^°'  ''^'''  "°  "'^"•^  '"^y  •'^  «°W,  usually, 
selling  price.    Therefore,  the  amount  of  money  which  mav  h» 
spent  for  materials,  for  manufacture,  for  selling'and  ad  JniL, 
.on  IS  circumscribed  more  or  less,  and  the  amount  of  prtrwh  ch 
can  be  realized  is  limited,  also.    Note  the  following: 

Selling  Price 


Cost  to 
Manufacture 


Selling 
Cost 


Administrative 
Cost 


mated  selling  and  administrative  cost,  and  a  definite  materi.al 


|, 


82 


ADVANCED  ACCOUNTING 


cost,  if  a  certain  amount  of  profit  is  desired,  it  becomes  absolutely 
necessary  to  keep  the  cost  to  manufacture  within  the  bounds  of 
the  remaining  space. 

The  same  idea  as  the  above  often  is  expressed  in  another  way. 
The  average  manufacturing  enterprise  divides  itself  into  three 
logical  sections: 

1.  A  manufacturing  section. 

2.  A  selling  section. 

3.  An  administrative  section. 

Each  section,  naturally,  contributes  certain  charges  toward  the 
ultimate  cost  of  the  product  which,  eventually,  comes  into  the 
hands  of  the  consumer, — the  purchaser: 

1.  Manufacturing  section. 

a.  Material. 

b.  Direct  labor. 

c.  Factory  overhead  or  burden. 

2.  Selling  section. 

a.  Selling  expenses. 

3.  Administrative  section. 

a.  Administrative  or  general  expenses. 
Therefore,  note  the  following: 


Material 

Direct 
Labor 


Prime  Cost 


Manufacturing 
Expense 


Factory  Cost 


Selling 
Expense 


Selling  Cost 


}   Total  Cost 


General 
Expense 


On  the  basis,  of  the  above  diagram,  the  following  definitions 
seem  to  be  in  order: 

1.  Direct  or  productive  labor.  Services  rendered  directly  in 
processing  the  product  through  the  various  operations.  The 
cost  of  these  services  can  be  applied  or  assessed  directly 


PARTNERSHIPS,  VENTURES,  CONTRACTS,  ETC.  83 

against  a  given  piece  of  product  work,  or  a  given  process 
in  connection  therewith,  by  merely  recording  the  time  a 
workman  commenced  operations  on  the  job  or  process  and 
when  he  stopped. 

2.  Indirect  or  non-productive  labor.  Services  rendered  in  the 
general  conduct  of  the  plant,— in  general  activities,  such  as 
stores  distribution,  supervision,  inspection,  time-keeping, 
planning,  repair  work,  and  promoting  the  general  welfare  of 
the  concern.  The  cost  of  these  services  cannot  be  applied 
or  assessed  directly  against  any  single  unit  of  product. 

3.  Material.  Raw  materials  are  materials  that  go  directly 
into  the  product,— into  a  particular  article,  job,  or  process. 
In  general,  the  cost  of  raw  material  is  the  vendor's  invoice 
plus  infreight  and  drayage.  The  quantity  used  is  deter- 
mined in  a  number  of  ways: 

a.  By  recording  the  material  actually  issued  from  stores. 

b.  By  weighing  or  measuring  the   completed  article  and 
allowing  for  water. 

4.  Prime  cost.  The  total  expenditure  for  raw  material  and 
direct  labor  of  any  kind  that  can  be  allocated  in  a  spe- 
cific amount  to  a  specific  article,  job,  or  process  because  of 
havmg  been  used  directly  thereon. 

5.  Factory  overhead  or  manufacturing  expenses.  All  outlays 
for  general  services  such  as  are  indicated  above  in  (2)  for 
indirect  labor,  for  taxes,  insurance,  depreciation  of  factory 
buildmgs  and  machinery,  power,  light,  heat,  sundry  sup- 
plies, etc.  The  cost  of  this  item  is  not  exceedingly  difficult 
to  ascertain,  but  only  close  study,  common  sense,  and  in- 
genuity will  enable  an  accountant  to  distribute  this  over- 
head among  the  products  manufactured.  These  overhead 
Items  are  distributable  or  diffusable  to  product  in  a  number 
of  ways,  at  best,  more  or  less  of  an  estimate,  tempered  by 
training  and  experience.  The  following  bases  are  illustra- 
tive: 

a.  Cost  of  productive  labor.  This  probably  is  the  oldest 
method  of  distribution.  It  consists  of  taking  the  total 
burden  for  a  department  or  for  the  plant  for  a  specific 
period  and  ascertaining  what  percentage  it  is  of  the 
money  paid  out  for  labor.     The  resultant  percentage 


84 


ADVANCED  ACCOUNTING 


is  added  to  each  job  according  to  the  amount  of  actual 
labor  charged  to  it. 

b.  Hourly  burden  plan.  This  may  be  more  satisfactory  than 
the  percentage  on  wages  method  in  that  time,  and  not 
wages,  is  the  basis  for  distribution.  The  total  burden 
of  a  department  for,  say,  a  month  is  divided  by  the 
number  of  hours  worked  during  the  month,  the  result 
being  what  is  called  an  "hourly  constant,"  this  to  be 
added  to  each  job  according  to  the  time  spent  thereon. 

c.  Machine  rate.  Hereunder,  the  factory  is  departmental- 
ized and  eacli  department  further  subdivided  into  what 
are  known  as  production  centers,  each  machine  or  work 
bench  at  which  a  workman  is  employed  being  considered 
a  production  center.  To  each  center  are  charged  all  ex- 
penses which,  upon  analysis,  can  be  allocated  thereto. 
These  charges  are  reduced  to  an  hourly  charge,  which 
may  be  termed  a  "rental  charge."  Each  job  passing 
through  a  production  center  is  charged  with  this  rental 
according  to  the  number  of  hours  worked  on  it.  When 
a  machine  is  idle,  the  rental  charge  goes  on  just  the  same, 
and  is  charged  into  what  is  known  as  a  "supplementary 
rate,"  which  later  will  be  charged  to  the  different  jobs 
according  to  the  time  spent  on  each,  or  on  a  percentage 
basis.  Besides  the  idle  time,  there  will  be  included,  also, 
in  this  rate  the  items  of  superintendent's  salary,  fore- 
men's salaries,  and  any  general  items  which  cannot  be 
allocated  to  the  different  specific  centers. 

Cost  Accounting  Defined.— Cost  accounting  is  that  branch 
of  accounting  which  furnishes  an  accurate  record  of  production 
costs  and  the  data  upon  which  the  management  may  judge  the 
efficiency  of  present  operations  and  plan  future  actions.  Costs 
may  be  determined  from  the  general  records  where  only  one 
kind  of  an  article  is  produced,  but  not  otherwise,  at  least  so  far 
as  unit  costs  are  concerned. 

Not  so  long  ago,  certain  accountants  made  a  distinction  be- 
tween cost  accounting  and  cost  finding,  the  latter  representing  a 
method  to  determine  what  the  cost  of  an  article  should  be  under 
present  conditions  in  advance  of  manufacturing  the  article,  as 
against  the  former  term  which  is  said  to  be  the  method  of  de- 


PARTNERSHIPS,  VENTURES,  CONTRACTS,  ETC.  85 

termining  what  the  cost  of  an  article  actually  is  while  the  arti- 
cle  IS  bemg  manufactured.     However,  the  opinion  is  ventured 
that  such  a  hair-splitting  distinction  is  not  followed  by  the  best 
of  cost  authorities;  it  appears  to  be  a  school-room  differentia- 
tion. 

The  main  purposes  or  more  important  uses  of  a  modern  cost 
system  may  be  set  out  about  as  follows: 

1.  Determination  of  unit  costs  to  be  used  as  a  guide  in  fixini 
selling  prices.  * 

2.  Securement  of  information  as  to  what  lines  are  profitable 
and  what  are  unprofitable. 

3.  Determination  at  any  time  of  the  value  of  material,  goods 
m  process,  and  finished  or  manufactured  product:  i  !  Z 
mamtamance  of  perpetual  inventories 

4.  By  means  of  perpetual  inventories,  waste  in  the  use  of  ma- 
tenals  and  product  may  be  eliminated  to  the  end  that  their 
use  will  be  only  as  intended. 

5.  Preparation  of  frequent  statements  of  operation  and  con- 

pS  rtot  r ""-^^ ''  — '  ^— ^es  :ri. 

6.  Frequent  statements  of  operation  and  condition  permit  the 
ready  estimate  of  future  financial  requirements  ™d  tt! 
ready  determination  of  future  policy  in  general  ' 

7.  Determination  of  efficiency  variation  as  to  operations  or 

^^ttrro^ab:^^'  i  t-*"^  -"^p"*-  ^^^^^'^ 

m  tne  cost  of  labor,  material,  and  overhead  expense 

Srrxr"""^  -'  ^  -» ~™^ "»- 

9.  Ascertainment  of  causes  of  increase  or  decrease  in  nrn 
duction  costs  as  compared  to  former  similar  oX  or  w  th 
the  standard  cost   ^n  thaf  A\ff..  ■         "^"^^s  or  with 

plained  thoroS'y  "  '"'*  "^^  "^  '"'- 

10.  Determination  of  profit  or  los^  Hn^  +^  ^^  • 

Cost  Methods  and  Factory  Orders     T>..  f  c  ■  . 


86 


ADVANCED  ACCOUNTING 


I 


Two  possible  methods  of  cost  finding  may  be  installed  within 
any  particular  plant,  separately  or  in  combination: 

1.  Process  method  (product  method).  This  method  may  be 
used  within  an  industry  or  within  certain  departments  of 
an  industry  ''where  there  is  mass  production,  either  con- 
tinuous or  intermittent,  or  both,  the  product  rc^quiring 
similar  operations,  though  perhaps  varying  in  size,  shape, 
appearance,  and  so  on;  or  where  the  goods  for  specific 
factory  orders  are  not  easily  distinguishable,  or  where  they 
become  part  of  a  volume  of  output."  (Walton:  Cost 
Course).  If  the  cost  of  a  specific  order  is  required,  costs 
are  distributed  thereto  on  a  quantity  basis. 

2.  Specific  order  method  (job  or  special  order  method).  This 
method  may  be  used  in  an  industry  where  a  special  type 
of  product  is  manufactured,  or  where  standard  articles 
are  fabricated  for  stock.  The  dissimilar  ord(»rs  going 
through  the  plant,  each  calling  for  a  special  kind  of  ma- 
terial and  special  methods  of  processing,  resulting  in  a 
variation  in  types  of  output,  make  the  process  method  of 
cost  finding  impossible.  Costs  are  collected  for  each 
specific  order,  as  to  material,  and  labor,  and  the  overhead 
is  distributed  to  each  order  upon  some  reasonable  basis. 
Hereunder,  factory  orders  must  be  issued  for  "the  manu- 
facture or  assembling  of  special  articles,  or  the  produc- 
tion of  standard  articles  for  stock."  (Walton:  Cost 
Course.) 

Under  the  second  method,  and  usually  under  the  first  one,  no 
work  is  begun  until  a  factory  order  has  been  issued.  These  orders 
are  of  three  kinds: 

1.  Production  orders.  These  orders  represent  the  authority 
under  which  the  factory  may  commence  the  fabrication  of 
the  product  therein  called  for.  Again,  sub-production  orders 
may  be  issued,  based  upon  production  orders,  in  order  to: 

a.  Ascertain  costs  by  departments,  by  operations,  or  both. 

b.  Keep  the  cost  of  special  patterns  or  tools  needed  on  an 
order  separate  from  the  cost  of  the  product. 

c.  Give  the  departments  information  as  to  work  coming 
through  from  other  departments,  or  as  authority  to  do 
work. 


PARTNERSHIPS,  VENTURES,  CONTRACTS,  ETC. 


87 


Again,  partial  production  orders  may  be  issued,  based 
upon  production  orders,  to  fabricate  a  part  of  what  the 
production  order  calls  for  where  the  quantity  thereon  speci- 
fied is  greater  than  can  be  handled  at  one  time.  Cost 
sheets,  upon  which  are  accumulated  the  labor,  material,  and 
overhead  expense  costs,  are  used  in  connection  with  each  of 
the  above  orders. 

2.  Betterment  orders.  When  the  factory  itself  is  to  do  the 
work  in  connection  with  additions,  and  improvements  to 
buildings,  machinery,  and  equipment,  betterment  orders  are 
issued  and,  in  connection  therewith,  the  charges  for  mate- 
rial, labor,  and  overhead  are  recorded  in  a  manner  similar 
to  that  used  in  connection  with  production  orders.  Cost 
sheets,  also,  may  be  used  with  betterment  orders. 

3.  Maintenance  orders.  These  orders  account  for  all  the  manu- 
facturing expenses  incurred  in  production.  They  are  of 
two  kinds: 

a.  Standing.  These  cover  the  account  classification  of 
manufacturing  expense  or  overhead.  They  are  issued 
from  time  to  time  as  a  change  is  made  in  such  classifica- 
tion, and  "stand"  during  each  such  interim. 

b.  Special.  These  cover  special  repair  work  whose  cost  is 
estimated  to  exceed  a  certain  fixed  sum,  as  $10.00. 

Methods  of  Control.— Two  methods  exist  for  keeping  the 
accounts  of  a  manufacturing  concern,  as  between  the  general 
oflSce  and  the  cost  department: 

1.  The  accounts  related  to  the  factory  activities  are  carried 
on  the  General  Ledger;  the  cost  department  is  considered 
as  a  department. 
These  factory  activity  accounts  are  of  two  classes: 

a.  Controlling  accounts. 

i.  Stores, 
ii.  Factory  cost, 
iii.  Cost  of  manufactured  product. 

b.  Statistical  accounts. 

i.  Payroll. 

ii.  Manufacturing  expense, 
iii.  Manufacturing  expense  distributed, 
iv.  Cost  of  manufactured  product  sold. 


88 


ADVANCED  ACCOUNTING 


2.  The  accounts  related  to  the  factory  activities  are  carried  on 
a  Factory  Ledger;  the  cost  department  is  considered  aa  a 
separate  company  or  branch.    As  concerns  the  factory: 

a.  General  Ledger.  Only  one  account  is  carried  thereon,  a 
controlling  account,  that  of  Factory  Ledger.  All  stores 
purchased,  expenses  incurred,  and  payroll  money  would 
be  charged  on  the  General  Ledger  to  Factory  Ledger. 

b.  Factory  Ledger.  This  would  be  a  regular  Ledger  kept  in 
the  cost  department,  and  the  factory  accounts  thereon 
would  be: 

i.  Controlling  accounts. 

1.  Stores. 

2.  Factory  orders. 

a.  Production. 

b.  Betterment. 

c.  Maintenance. 

3.  Cost  of  manufactured  product. 

4.  Cost  of  manufactured  product  sold, 
ii.  Statistical  accounts. 

1.  Payroll. 

2.  Manufacturing  expense. 

3.  Manufacturing  expense  distributed. 

Control  Entries. — Pro  forma  entries  illustrative  of  the  pro- 
cedure indicated  above  in  the  last  section  would  be  about  as 
shown  below.  Further,  these  entries  have  been  grouped  into 
four  divisions  or  sections: 

1.  Material. 

2.  Labor. 

3.  Manufacturing  expenses. 

4.  Production  and  sales. 


PARTNERSHIPS,   VENTURES,  CONTRACTS,  ETC. 


89 


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CORPORATIONS— OPENING  ENTRIES 


93 


t 


CHAPTER  IV 

CORPORATIONS:  DEFINITIONS;  OPENING 

ENTRIES 

Introduction. — Three  general  forms  under  which  business 
activities  are  conducted  have  been  pointed  out  in  the  accounting 
work  thus  far  covered: 

1.  Sole  proprietorship.  A  business  conducted  by  an  individual 
on  his  own  account  and  for  his  own  benefit.  The  general 
accounting  principles  hereunder  are  those  usually  studied 
in  the  work  of  the  first  year. 

2.  Partnership.  A  business  owned  by  two  or  more  individuals, 
and  conducted  on  a  cooperative  basis  for  mutual  benefit, 
the  partners  having  a  share  both  in  its  management  and  in 
its  profits.  The  general  accounting  principles  hereunder 
differ  in  no  way  from  those  applicable  to  a  sole  proprietor- 
ship, except  as  to  the  following. 

a.  Opening  entries. 

b.  Profit  sharing  and  distribution. 

c.  Dissolution  and  liquidation. 

3.  Corporation.  A  business  conducted  for  the  benefit  of  thf 
stockholders  through  a  board  of  directors,  their  elected 
representatives.  The  corporation  owns  the  business  and 
the  stockholders  own  the  corporation.  Although  the  gen- 
eral principles  of  operative  accounting  practically  are 
the  same  in  a  corporation  as  in  a  partnership  and  sole 
proprietorship,  there  are  many  principles  which  are  pecu- 
liarly corporate.  The  greater  portion  of  the  remainder  of 
this  volume  is  devoted  to  a  consideration  of  the  principles 
and  allied  procedures  peculiarly  corporate  in  character. 

In  connection  with  corporate  problems,  it  is  difficult  ofttimes 
to  distinguish  clearly  between  law,  finance,  and  accounting,  since 
all  three  subjects  overlap  to  an  appreciable  extent.  Therefore, 
at  times,  reference  must  be  made  in  the  subsequent  discussions 

92 


to  one  or  both  of  the  subjects  mentioned  other  than  account- 
ing. The  law  will  be  referred  to  frequently,  both  in  general  and 
as  set  out  specifically  in  the  New  York  statutes.  The  latter 
are  especially  representative  of  states  considered  as  having  the 
most  intelligent  corporate  laws.  In  this  connection,  the  cita- 
tions thereto  will  be  abbreviated  as  follows : 

1.  General  Corporation  Law — G.  C.  L. 

2.  Business  Corporations  Law — B.  C.  L. 

3.  Stock  Corporation  Law — S.  C.  L. 

The  subject  of  corporations  has  attracted  considerable  public 
notice  during  recent  years,  in  part,  because  the  corporate  form 
of  organization,  for  reasons  to  be  noted  later  in  detail  related  to 
permanency  of  organization  and  limited  liability  attaching  to 
persons  therein  interested  as  stockholders,  has  simplified  the 
complexity  of  modern  business  demands,  and  has  made  pos- 
sible the  carrying  out  of  many  great  achievements.  Under  cer- 
tain conditions,  though  its  privileges  at  times  have  been  most 
shamefully  abused,  the  corporation  is  the  "only  safe,  rational 
and  efficacious  means  of  uniting  capital  for  the  promotion  of 
any  business  enterprise." 

Corporation  Defined.— Although  various  definitions  of  a  cor- 
poration are  to  be  found,  the  only  difference  between  them  ap- 
pears to  be  in  their  viewpoint.  The  following  are  well-known 
and  illustrative: 

1.  ''An  artificial  being,  invisible,  intangible,  and  existing  only 
in  contemplation  of  law."     (4  Wharton  636.) 

2.  "An  artificial  person  created  for  preserving  in  perpetual 
succession  certain  rights,  which  being  conferred  on  natural 
persons  only,  would  fail  in  the  process  of  time."  (Black- 
stone.) 

3.  "A  corporation  is  a  person  which  exists  in  contemplation  of 
law  only  and  not  physically.  It  is  a  collection  of  many 
mdividuals  united  in  one  body  under  a  special  denomina- 
tion, having  perpetual  succession,  under  an  artificial  form, 
and  vested  by  the  policy  of  the  law  with  the  capacity  of 
actmg  in  several  respects  as  an  individual,  particularly  of 
takmg  and  granting  property,  of  contracting  obligations 
and  of  suing  and  being  sued,  of  enjoying  privileges  and 
immunities  m  common  and  of  exercising  a  variety  of  politi- 


#1 


94 


ADVANCED  ACCOUNTING 


cal  rights,  more  or  less  extensive,  according  to  the  design  of 
its  institution,  or  the  powers  conferred  upon  it  at  the  time 
of  its  existence."     (1  Kyd  13.) 
4.  "A  body  created  by  law,  composed  of  individuals  united 
under  a  common  name,  the  members  of  which  succeed  each 
other,  so  that  the  body  continues  the  same,  notwithstand- 
ing the  individuals  who   compose  it,   and   is,   for   certain 
purposes,  considered  as  a  natural  person."      (Angel   and 
Ames  on  Corporations.) 
Numerous  other  definitions  could  be  cited,  if  space  permitted 
(23  Wend.  103;  57  U.  S.  314;  etc.),  and  tlie  greater  part  of  the 
differences  of  opinion  and  consequent  discussion  thereon  could 
be  harmonized  satisfactorily.     It  is  axiomatic  that  all  powers 
spring  primarily  from  the  Sovereign,  or  the  People.    The  People 
select  their  representatives, — the  legislature.     To  this  body  is 
given  the  power  to  create  corporations  and  endow  them  with 
powers,  rights,  privileges  and  immunities;  subject,  however,  to 
such  duties,  obligations  and  conditions  as  the  legislature  may 
deem  proper.     These  powers,  rights,  privileges  and  immunities 
must  be  within  the  Constitution  and  the  law.  State  and  Federal. 
It  is  right  at  this  point, — relative  to  this  power  and  capacity  to 
create  out  of  certain  persons  and  their  successors  an  "artificial 
person,"  a  "legal  entity,"  and  giving  it  a  name,  make  it  a  resi- 
dent  of  the  State,  with  power  to  buy  and  sell  and  to  exercise  the 
other  powers,  rights,  privileges   and   immunities,   belonging  to 
natural  persons, — ^that  the  stumbling  block  exists  for  many  who 
have  discussed  the  subject. 

At  its  inception,  the  corporation  is  composed  both  of  the  living, 
existing  individuals  described  in  its  charter,  and  their  successors, 
whoever  the  latter  may  be.  These  successors  are  a  part  of  the. 
corporation  even  though  their  identity  cannot  be  disclosed  ex- 
cept through  the  efflux  of  time.  Succession  is  one  of  the  most 
vital  elements  of  a  corporation.  Shares  of  stock,  being  con- 
vertible, pass  readily  from  owner  to  owner.  A  few  weeks  may 
be  sufficient  for  the  original  incorporators  to  pass  from  the 
scene  and  be  replaced  by  the  unknown  successors.  Th(?refore, 
with  reason,  it  is  impossible  to  say  that  the  corporation  and  its 
members  (stockholders)  are  one.  Because  of  this,  the;  long- 
established  and  well-authenticated  definitions  of  a  corporation 


CORPORATIONS^OPENING  ENTRIES 


95 


still  remain  regardless  of  all  the  attempts  made  to  erase  the 
"legal  fiction." 

However,  it  should  be  remembered  that  a  corporation  is  an 
artificial  being,  a  legal  entity,  entirely  separate  and  distinct 
and  apart  from  those  who  own  and  hold  its  capital  stock  just 
so  long  and  so  far  as  justice  and  equity  deem  it  necessary  so 
to  be  considered.  When  it  appears  clearly  that  this  entity 
with  all  its  powers,  rights,  privileges,  and  immunities  tends 
toward  some  wrongful  end,  immediately,  in  equity,  the  corpora- 
tion becomes  merely  an  association  of  individuals  whose  wrong- 
doing the  Courts  will  remedy  or  restrain.  (Spelling:  Private 
Corporations,  vol.  11,  sec.  541.) 

Corporation  Distinguished  From  Partnership. — Note  the 
following  comment  on  the  difference  between  a  partnership  and 
a  corporation  (Angel  and  Ames  on  Corporations) : 

"The  difference  between  a  company  established  for  private  hazard 
and  profit  by  an  act  or  charter  of  incorporation  and  an  ordinary  co- 
partnership is  obvious  and  striking.  The  latter  is  simply  a  voluntary 
contract,  and  the  result  of  such  a  contract,  whereby  two  or  more  per- 
sons agree  to  combine  their  property  or  labor,  or  both,  for  the  purpose 
of  a  common  undertaking  and  the  acquisition  of  a  common  profit; 
and  the  gain  or  loss  is  to  be  proportionately  shared  between  them. 
But  this  definition  greatly  falls  short  of  a  company  established  as  a 
body  corporate,  which,  though  originating  in  a  voluntary  contract,  is 
the  result  not  only  of  that,  but  of  its  confirmation  by  special  legislative 
authority.  This  confirmation  is  indispensable  to  enable  the  parties  to 
the  compact  to  sue  and  be  sued,  as  a  company,  by  a  general  name,  to 
act  by  a  common  seal  and  to  transmit  their  property  in  succession. 
One,  if  not  the  principal  and  main  inducement,  in  procuring  an  act  of 
incorporation  is  to  limit  the  risk  of  the  partners  and  to  render  definite 
the  extent  of  their  hazard;  for  it  is  a  perfectly  well-settled  rule  of  law 
that  each  member  of  a  common  partnership,  whether  active,  nominal 
or  dormant,  is  the  accredited  agent  of  the  others,  and,  as  such,  has  au- 
thority to  bind  them,  to  the  extent  of  their  private  property,  by  any 
simple  contract  he  may  make,  either  respecting  the  goods  or  business 
of  the  concern,  or  by  negotiable  instruments  in  its  behalf  to  any  person 
dealing  bona  fide.  This  personal  responsibility  of  a  stockholder  is 
inconsistent  with  a  perfect  body  corporate;  and  therefore,  where  an 
execution  issued  against  a  corporation  by  the  name  of  *  President, 
Directors  and  Company,'  with  special  instruction  to  the  officer  to  take 


96 


ADVANCED  ACCOUNTING 


their  bodies  for  want  of  estate,  no  authority  was  communicated  to  him 
thus  to  do.  And  the  stockholders  of  a  corporation  do  not  become*  liable 
as  partners,  on  notes  given  by  the  treasurer  of  the  corporation,  merely 
because,  after  organizing  under  the  act  of  incorporation,  no  corporate 
business  is  transacted  or  because  the  notes  were  given  for  debts  l)eyond 
the  corporate  authority  of  the  company." 

One  must  not  forget,  as  indicated  above  already,  that  since  a 
corporation  exists  as  a  legal  fiction,  independently  of  its  mem- 
bers, it  must  derive  its  character  from  the  persons  who  direct 
it.  These  latter,  because  of  the  fact  that  the  nature  of  the 
corporation  makes  it  a  mere  legal  abstraction,  must  be  the  ones 
to  suffer  should  they  be  guilty  of  misconduct  under  the  law,  and 
of  committing  in  its  name,  what  are  known  in  law  as  "ultra 
vires  acts." 

Corporation  Distinguished  From  Joint  Stock  Company. — 
A  joint  stock  company  is  composed  of  numerous  partners,  the 
ownership  in  the  enterprise  being  evidenced  by  shares  as  in 
the  case  of  a  corporation.  It  has  the  following  characteristics 
in  common  with  corporations: 

1.  Any  member  may  transfer  his  ownership  interest  therein 
without  or  with  the  consent  of  the  other  partners. 

2.  A  board  of  directors  controls  the  body  so  that  no  member, 
as  such  has  agency  powers  to  act  for  the  company. 

On  the  other  hand,  it  differs  from  a  corporation  in  that: 

1.  The  members  are  liable  for  the  debts  jointly  and  severally. 

2.  A  joint  stock  company  sues  and  defends  in  the  name  of  an 
ofiicer;  a  corporation  sues  and  defends  in  its  own  name. 

The  creation  of  a  corporation  merges  m  the  artificial  body 
and  draws  in  the  individual  rights  and  liabilities  of  the  mem- 
bers, while  the  organization  of  a  joint  stock  company  leaves 
the  individual  rights  and  liabilities  unimpaired  and  in  full 
force.  (See  7  Hill  312;  2  Denio  380).  Joint  stock  companies, 
as  a  means  of  combination,  have  become  antiquated  and  fallen 
into  deserved  disuse.  No  longer  can  they  ])e  said  to  exist  outside 
of  the  statute;  therefore,  in  America,  they  are  almost  obso- 
lete. Joint  stock  companies  are  common  in  England;  and  if 
the  members'  liability  therein  is  limited,  the  name  of  the  con- 
cern will  have  at  the  end  of  the  term  ''Ltd.,"  which  means 
"limited." 


CORPORATIONS— OPENING  ENTRIES 


97 


Advantages  of  the  Corporate  Form  of  Organization. — 
Corporate  activities  are  subject,  more  or  less,  to  certain  legal 
and  customal  restrictions  supposed  to  benefit  both  the  corporate 
stockholders  and  outsiders  having  business  dealings  with  the 
corporation.  The  sole  trader,  in  his  independent  search  for 
wealth,  may  do  about  as  he  pleases  toward  the  accomplishment 
of  this  purpose  so  long  as  he  does  not  interfere  with  public 
policy  or  with  the  rights  of  others.  Under  certain  conditions, 
his  business  must  be  registered,  and  he  must  obey  the 
local  police  regulations  at  all  times.  Partnership  activities, 
likewise,  are  subject  more  or  less  to  certain  restrictions,  both 
legal  and  customal,  whose  purpose  is  supposed  to  benefit  both 
the  partners  and  outside  persons  who  are  brought  into  busi- 
ness contact  with  these  partners. 

Since  the  present  volume  is  devoted  primarily  to  corporations, 
the  merits  and  disadvantages  of  either  of  the  above  two  forms 
of  business  organization  are  of  no  present  interest  except  by  way 
of  comparison  with  those  of  the  corporate  form  of  organization. 

The  principal  advantages  gained  from  incorporating  a  busi- 
ness may  be  set  out  as  follows: 

1.  Ability  to  secure  greater  capital.  The  corporate  form  of 
organization  provides  for  increased  capital  by  the  sale  of 
shares  to  outside  investors.  The  small  investor  may  invest 
small  amounts  with  advantage,  and  the  capitalist  may 
spread  his  investments  over  a  number  of  enterprises,  each 
without  being  required  to  devote  any  time  whatsoever  to 
management  problems,  or  without  being  required  to  as- 
sume the  indefinite  risk  attached  to  either  one  of  the  other 
two  forms  of  organization. 

2.  Limited  liability.  A  stockholder's  liability,  in  general,  is 
limited  to  the  amount  of  his  stock.  Even  in  the  case  of  a 
bank,  where  this  liability  is  for  double  the  amount  of 
stock  held,  such  liability,  nevertheless,  is  limited.  The 
liability  of  a  sole  trader  or  partner  may  place  his  entire 
fortune  in  jeopardy. 

3.  Permanent  organization.  A  corporation  continues  its  exist- 
ence regardless  of  any  change  in  the  stockholders'  personnel ; 
it  exists  for  the  period  of  time  specified  in  the  charter, 
unless  sooner  dissolved  by  vote  of  the  stockholders  or  by 


98 


ADVANCED  ACCOUNTING 


CORPORATIONS—OPENING   ENTRIES 


99 


action  of  the  state  from  which  the  charter  was  received.  A 
sole  trader  or  partnership  organization  is  dissolved  by  the 
death,  insolvency,  insanity,  or  withdrawal  of  a  member. 

4.  Transferability  of  interest.  A  corporate  stockholder  is  free 
to  dispose  of  his  share  holdings  as  he  may  see  fit,  as  by  sale 
or  will,  without  the  consent  of  the  others,  except  in  the  case 
of  a  pooling  agreement.  Again,  a  stockholder  can  j)ledge 
his  holdings  as  security  for  loans  without  prejudice  to  the 
business.  A  partner  cannot  dispose  of  his  firm  int(;rest 
except  with  the  consent  of  the  other  partners,  or  by  wind- 
ing up  the  business;  neither  can  he  pledge  his  partnership 
interest  as  security. 

5.  Improved  organization  efficiency.  In  a  corporation,  no 
stockholder,  as  such,  may  transact  corporate  business  with 
outsiders.  A  corporation  is  managed  by  a  board  of  direc- 
tors who  periodically,  in  meeting  assembled,  outline  the 
general  business  policy  and  who,  between  these  periodical 
meetings,  delegate  the  actual  conduct  of  the  business  to 
certain  officers  who  are  given  definite  powers,  and  whose 
actions  are  subject  to  criticism  by  the  entire  body  of  stock- 
holders when  the  latter  come  together  at  their  annual 
meeting.  Dispute  and  dissension  are  common  in  partner- 
ship enterprises  and  difficult  to  eliminate,  since  it  is  not 
easy  for  two  or  more  partners  to  oust  another  who  seems 
unsatisfactory  to  them.  In  a  corporation,  it  is  an  easy 
matter,  relatively  speaking,  as  compared  with  a  partnership, 
for  the  directors  or  stockholders  to  drop  an  ofiicer  wliose 
conduct  is  unsatisfactory. 

6.  Improved  borrowing  facilities.  Frequently,  a  corporation, 
when  it  needs  additional  capital,  may  raise  the  money 
readily  by  marketing  an  issue  of  preferred  stock  with  a 
preferred  dividend  feature  making  it  an  attractive  invest- 
ment, or  by  floating  an  issue  of  bonds,  by  going  to  its  own 
stockholders  as  a  source  of  supply.  Tlie  stockholders  who 
invest  get  the  same  security  as  an  outsider  and  are  placed 
in  the  same  preferred  position,  in  this  particular,  as  any 
outside  investor.  If  a  sole  trader  advances  money  to  his 
business  beyond  his  original  investment,  his  position  is  no 
more  preferred  thereafter  than  before ;  being  the  proprietor, 


everything  he  has  is  at  stake  to  satisfy  the  demands  of 
creditors.  If  a  partner  advances  money  to  his  partnership, 
his  position,  likewise,  is  not  the  same  as  that  of  outside 
creditors,  since  the  latter  must  be  satisfied  entirely  before 
he  has  a  right  to  the  return  of  anything. 
Disadvantages  of  the  Corporate  Form  of  Organization.— 
Some  of  the  disadvantages  of  the  corporate  form  are: 

1.  Restriction  of  power.  A  corporation  is  restricted  to  the 
kind  of  business  for  which  it  was  incorporated.  The  cor- 
porate charter  (the  contract  entered  into  between  the  state 
and  the  incorporators)  defines  and  limits  the  scope  of  cor- 
porate power.  If  a  change  in  this  particular  is  desired,  the 
consent  of  the  state,  under  whose  laws  the  corporation  was 
formed,  must  be  secured.  A  partnership  can  conduct  any 
legal  business,  and  may  change  from  one  business  to  an- 
other without  consulting  the  state  officials.  Because  of  this 
restriction  as  to  the  character  of  the  business  that  may  be 
carried  on,  corporations  more  and  more  are  being  formed 
With  broad  charter  powers  so  as  to  avoid  the  necessity  of 
securing  frequent  subsequent  consent  on  the  part  of  the 
state. 

2.  Limitation  of  credit.  A  new  corporation  may  find  it  difficult 
to  secure  the  credit  necessary  with  which  to  carry  on  its 
activities.  Creditors  may  be  willing  to  grant  credit  to  a 
firm  or  to  individuals  with  their  unlimited  liability,  but 
they  may  be  reluctant  to  exlend  the  same  credit  to  a  new 
corporation  whose  liability  is  limited,  as  to  its  members,  to 
the  investment  made  therein  by  them.  This  reluctance  may 
be  so  great  that  credit  will  not  be  granted  unless  the  cor- 
porate ofiicers,  as  individuals,  endorse  the  company's  notes. 

3.  Restriction  in  freedom  of  action.  If  prompt  action  is  neces- 
sary in  a  corporation  to  meet  a  contingency  tliat  has  arisen 
suddenly,  this  will  be  more  or  less  impossible  where  a  formal 
meeting  of  the  board  of  directors  is  necessary,  since  such 
meeting  cannot  be  held  without  first  giving  due  notice  to 
each  member.  On  the  other  hand,  prompt  action  by  a 
majority  of  a  firm's  partners  may  be  secured  readily. 

4.  Governmental  supervision.  State  and  federal  governments, 
through  their  various  boards,  may  exercise  a  control  over 


100 


ADVANCED  ACCOUNTING 


business   corporations   that   is  decidedly   annoying,   if   not 
burdensome. 

5.  Inability  to  hold  stock  in  other  corporations.  Some  states 
prohibit  one  corporation  from  holding  stock  in  another. 

6.  Majority  control.  One  of  the  greatest  disadvantages  of  a 
corporation  is  that  the  majority,  in  general,  control  and 
conduct  affairs  after  their  own  ideas;  on  the  other  hand,  in 
a  partnership  the  majority  and  minority  interests  are  pro- 
tected alike.  However,  this  disadvantage  may  be  avoided 
by  giving  the  minority  stockholders,  at  the  time  the  com- 
pany is  formed: 

a.  Half  the  voting  stock. 

b.  The  right  to  elect  half  the  directors. 

c.  The  right  to  cumulative  voting.  By  this  means,  a  stock- 
holder has  one  vote  for  each  share  of  stock  held  for  each 
director  to  be  elected.  By  this  means,  the  minority, 
through  pooling  their  votes,  may  secure  representatives 
upon  the  board. 

Classification  of  Corporations.— The  General  Corporation 
Law  of  New  York,  which  is  practically  the  same  as  the  statutes 
in  many  other  states,  specifies  that  a  corporation  shall  be  either: 

1.  A  municipal  corporation. 

2.  A  stock  corporation. 

a.  A  moneyed  corporation. 

b.  A  railroad  or  other  transportation  corporation. 

3.  A  non-stock  corporation. 

a.  A  religious  corporation. 

b.  A  membership  corporation. 

c.  Any  corporation  other  than  a  stock  corporation  (Arti- 
cle 1). 

The  above  classification  would  seem  to  be  complete  if  a  fourtli 
grouping  were  added: 

4.  Mixed  corporations. 

a.  Cemetery  corporation. 

b.  Library  corporation. 

c.  Board-of-trade  corporation. 

d.  Agricultural  and  horticultural  corporation. 

A  municipal  corporation  includes  a  county,  a  town,  a  school 
district,  a  village,  a  city,  and  any  other  territorial  state  division 


CORPORATIONS— OPENING  ENTRIES 


101 


which  is  established  by  law,  and  which  exercises  powers  of  local 
government.  A  municipal  corporation  is  a  public  corporation. 
A  stock  corporation  is  one  with  its  capital  stock  divided  into 
shares  and  which,  by  law,  may  distribute  dividends  from  its 
surplus  profits  to  the  holders  of  its  shares.  A  corporation  is  not 
a  stock  corporation  merely  because  it  issues  certificates  which 
represent  membership  only.  A  moneyed  corporation  is  one 
formed  under  or  subject  to  the  banking  or  insurance  acts.  A 
non-stock  corporation  is  one  whose  purpose  is  charitable,  re- 
ligious, educational,  etc.  In  fact,  the  term  includes  every  corpo- 
ration other  than  a  stock  corporation,  even  though  the  above 
classification  would  not  seem  to  indicate  such  fact. 

Variations  as  to  the  classification  of  corporations  would  appear, 
in  summary  form,  about  as  follows: 

1.  As  to  purpose. 

a.  Those  organized  for  profit. 

b.  Those  not  organized  for  profit. 

2.  As  to  ownership. 

a.  Public  or  governmental. 

b.  Private. 

i.  Stock  companies ;  those  operated  for  profit. 

a.  Sole— All  stock  held  by  one  person,  or  perhaps 
all  but  a  few  shares  held  by  one  person. 

b.  Close— All  stock  held  by  but  few  persons,  and 
not  generally  traded  in. 

c.  Open— Stock  freely  purchased  and  sold. 

ii.  Non-stock  companies ;  those  not  operated  for  profit. 

3.  As  to  fact  of  incorporation. 

a.  De  jure— Those  legally  incorporated. 

b.  De  facto— Those  which  have  not  met  fully  all  the  legal 
requirements,  but  which  to  all  intents  and  purposes  are 
corporations  in  fact. 

4.  As  to  sovereignty. 

a.  Domestic— Those  organized  under  the  laws  of  the  state 
in  which  they  do  business. 

b.  Foreign— Those  organized  under  the  laws  of  a  state  other 
than  that  in  which  they  do  business. 

The  corporate  discussion  of  the  present  volume  is  concerned 
with  private  corporations  organized  for  profit. 


102 


ADVANCED  ACCOUNTING 


Incorporation  Procedure. — It  may  be  stated,  in  general,  that 
the  laws  of  the  various  states  governing  the  incorporation  of  a 
company  require  that  three  or  more  persons  must  prepare  the 
application  to  be  filed  with  the  Secretary  of  State,  and  that  this 
application,  after  publication  in  an  approved  manner,  after  ap- 
proval by  the  proper  officials,  and  after  payment  of  the  requinite 
fees,  becomes  the  certificate  of  incorporation  or  the  charter  of 
the  corporate  body.  Following  this,  or  concurrent  therewith,  the 
stockholders  complete  the  other  necessary  organization  details, 
such  as  adopting  the  by-laws,  electing  the  directors,  and  doing 
whatever  else  appears  necessary  to  place  the  business  at  a  point 
where  it  may  commence  to  conduct  its  operations,  after  wliich 
operations  as  a  corporation  begin. 

In  New  York,  "a  certificate  of  incorporation  must  be  executed 
by  natural  persons,  who  must  be  of  full  age,  and  at  least  two- 
thirds  of  them  must  be  citizens  of  the  United  States  and  one  of 
them  a  resident  of  this  state."  The  above  rule,  however,  does 
"not  apply  to  a  corporation  formed  by  the  reincorporation  or 
consolidation  of  existing  corporations,  or  to  the  reorganization  of 
a  corporation  upon  the  sale  of  the  property  and  franchises  of  a 
previously  existing  corporation  or  otherwise."  (G.  C.  L.,  Art.  2, 
Sec.  4.) 

Stockholders. — The  owners  of  a  corporation  are  titled  "stoc^k- 
holders."  They  correspond  to  the  partners  in  a  partnersliip. 
Stockholders,  except  as  ofiicers  or  directors,  take  no  active  part 
in  the  corporate  operations;  in  a  partnershij),  all  the  partners 
may  do  so,  and  some  of  them  must  do  so.  Corporate  ownership 
is  evidenced  by  "shares  of  stock,"  each  share  representing  a  sj)eci- 
fied  equal  part  of  the  total  corporate  property  capable  of  being 
owned. 

At  common  law,  the  stockholders  have  the  right  to  make  the 
code  of  rules  under  which  the  corporation  is  governed  in  con- 
junction with  its  charter  and  the  statutes.  These  rules  are  known 
as  "by-laws."  The  stockholders  have  a  right  to  elect  a  board 
of  directors,  who  are  responsible  to  them  for  the  manner  in  which 
the  corporation  is  operated.  In  some  cases,  where  the  statutes 
or  charter  permit,  or  where  the  stockholders  by  lawful  action 
give  their  consent,  the  board  of  directors  may  make  the  by-laws, 
or  change  them  as  desired. 


CORPORATIONS— OPENING  ENTRIES 


103 


The  Corporate  Charter. — Before  discussing  in  any  way  the 
corporate  charter,  it  may  not  be  amiss  first  to  define  three  terms 
used  in  connection  therewith: 

1.  Charter.  An  instrument  by  which,  in  the  United  States,  the 
sovereign  people,  through  the  legislature  as  their  represen- 
tative agents,  by  special  grant  and  enactment,  create  bodies 
corporate  and  clothe  them  with  miscellaneous  and  sundry 
rights,  powers,  privileges  and  immunities. 

2.  Franchise.  A  franchise  is  not  a  charter,  although  often 
spoken  of  as  such;  again,  it  is  often  used  to  denote  the 
corporation  itself.  In  reality,  it  is  the  right  or  privilege 
which  is  conveyed  and  bestowed  upon  the  corporation  by 
the  charter. 

3.  Certificate  of  incorporation.  This  is  a  term  in  use  since  the 
enactment  of  general  incorporation  laws.  However,  it  seems 
to  be  a  misnomer.  In  the  early  days,  all  corporations  were 
created  by  special  enactment  of  the  legislature  and  a  charter 
in  due  and  regular  form  was  taken  to  be  an  absolute  neces- 
sity prerequisite  to  corporate  life  and  existence.  In  other 
w^ords,  formerly  all  corporate  existence,  in  the  absence  of 
general  laws,  was  based  upon  the  possession  of  a  charter, 
and  a  special  petition  to  the  legislature  and  the  latter's 
aflSrmative  act  were  required  in  every  case  wherein  a  cor- 
poration was  to  be  created.  Since  favoritism  often  crept  in 
in  the  granting  of  these  charters,  the  People,  with  well- 
advised  insistence,  began  to  demand  that  in  regard  to  this 
matter  of  corporate  creation,  and  in  the  granting  of  cor- 
porate rights,  etc.,  there  should  be  absolute  equality  to  all 
and  favoritism  to  none,  and  that  citizens  might,  in  the 
matter  of  corporate  creation  and  endowment,  obtain  as  an 
absolute  right  that  which  theretofore  could  be  had  only  by 
petition  to  the  legislature.  This  demand  plus  the  existing 
need  of  securing  the  benefits  which  accrue  to  business  and 
commerce  from  the  aggregation  of  capital  and  the  fore- 
stallation  of  death,  advantages  to  be  had  only  through  the 
mstrumentality  of  private  business  corporations,  compelled 
the  various  states  to  enact  general  incorporation  laws.  Sub- 
stantially, all  these  laws  have  the  same  features.  There- 
fore, notwithstanding  technicalities   and  numerous  defini- 


104 


ADVANCED  ACCOUNTING 


CORPORATIONS— OPENING  ENTRIES 


105 


tions,  the  instrument  which  is  either  an  evidence  of  the 
performance  of  all  the  formalities  required  by  the  incorpora- 
tion law,  or  a  declaration  of  the  intent  and  purpose  of  the 
incorporators  to  avail  themselves  of  the  benefits  of  the  act, 
— whether  it  be  a  certificate  or  a  declaration,  or  both, — is, 
when  read  and  construed  in  connection  with  the  law,  prac- 
tically the  same  thing  as  a  charter,  because  it  is  the  legally 
provided  substitute  therefor. 
The  charter  of  a  corporation,  whatever  its  name  and  however 
conferred,  is  a  contract  by  and  between  the  sovereign  creating 
power  as  the  party  of  the  first  part  and  the  aggregation  of 
persons  forming  the  corporation  and  their  successors,  the  party 
of  the  second  part:  Under  which  the  creating  party,  the  state, 
grants  to  the  other  party,  the  incorporators,  within  the  limita- 
tions and  restrictions  of  law,  certain  rights,  powers,  privileges 
and  immunities;  this  contractual  element  extends  beyond  the 
creating  power  and  the  corporation,  and  exists  not  only  between 
the  corporation  and  its  members,  but  between  the  corporation 
and  the  public  (a  sort  of  tripartite  agreement),  comprehending 
not  only  the  persons  named  originally,  but  all  those  who  may, 
shall,  or  will  succeed  them. 

Since  the  charter  is  a  contract,  it  cannot  be  rescinded  by  the 
act  of  one  party  without  the  consent  of  the  other.  A  grant  of 
corporate  privileges  for  a  specified  period  cannot  be  resumed  by 
the  state  within  such  period.  If  the  charter  be  without  limitation 
as  to  time,  it  is  forever  irrepealable.  However,  when  the  cor- 
porate privileges  have  been  abused,  the  courts  may  pronounce 
them  forfeited.  In  some  cases,  the  legislature,  when  granting 
the  franchises,  reserves  to  itself  the  right  to  revoke  them;  if  the 
charter  contains  such  a  stipulation,  the  latter  is  as  much  a  part 
of  the  contract  as  anything  else  that  is  in  it.  The  power  to 
repeal  sometimes  is  reserved  absolutely,  so  that  the  franchises 
of  the  corporation  may  be  revoked  whenever  the  legislature  may 
think  proper.  Again,  the  power  of  repeal  may  be  reserved  con- 
ditionally, to  be  exercised  only  in  case  a  certain  event  shall 
happen;  when  such  event  does  happen,  the  cliarter  is  repealable, 
whether  the  event  be  one  the  corporators  could  not  control  or 
one  that  could  not  occur  without  some  default  of  their  own. 


Capital  Versus  Capital  Stock.— The  capital  stock  of  a  cor- 
poration is  the  amount  for  which  the  company  is  incorporated 
under  the  law,— the  amount  of  stock  it  is  authorized  to  issue. 
The  charter  specifies  how  much  capital  stock  may  be  issued,  and 
this  cannot  be  changed  except  by  charter  amendment.  The  total 
capital  stock  as  fixed  by  the  incorporators,  usually,  may  be  any 
amount  desired,  so  long  as  it  equals  the  minimum  prescribed  by 
law  as  the  smallest  amount  with  which  a  corporation  may  begin 
business.  Statutory  requirements  governing  the  issuance  of  capi- 
tal stock  vary  from  state  to  state.  In  New  York,  the  amount 
of  capital  stock  shall  be  "not  less  than  five  hundred  dollars  " 
(B.  C.  L.,  Art.  2.) 

The  determination  of  the  amount  of  stock  which  a  corporation 
is  to  be  authorized  by  law  to  issue  depends  upon  a  number  of 
factors : 

1.  The  amount  needed  to  develop  the  proposition. 

2.  The  cash  value  of  property  to  be  taken  over. 

3.  The  probable  earning  power  of  the  new  enterprise. 

4.  The  actual  earning  power  of  the  old  business  from  which 
the  new  corporation  is  an  outgrowth. 

5.  Combinations  of  (1-4),  above. 

When  one  speaks  of  corporate  capital  as  against  capital  stock, 
he  should  keep  in  mind  the  elementary  distinction  between  eco- 
nomic and  accounting  capital: 

1.  Economic  capital  represents  the  whole  fund  of  assets  em- 
ployed regardless  of  whether  or  not  it  has  been  contributed 
by  the  proprietors  of  the  enterprise  or  by  others.  Account- 
ing capital  represents  only  the  difference  between  the  total 
asset  values  recorded  and  the  third-party  liabilities  which 
eventually  must  be  paid  therefrom;  it  represents  proprie- 
torship. 

2.  The  capital  of  a  corporation  relates  to  the  difference  between 
the  assets  into  which  the  capital  contributions  have  been 
converted  and  the  third-party  liabilities  resulting  from  the 
activities  of  the  corporate  personality.  It  is  seen,  therefore, 
that  its  amount  would  be  determined  in  a  manner  similar  to 
that  followed  in  determining  the  accounting  capital  of  a  sole 
trader  or  partnership.     On  the  other  hand,  capital  stock 


106 


ADVANCED  ACCOUNTING 


I 


represents  the  actual  liability  of  the  corporate  personality 
to  the  shareholders  for  the  capital  they  either  have  paid  in 
or  subscribed  for,  which  must  be  paid  in  eventually  plus 
whatever  difference  remains  as  between  the  above  two 
amounts  and  the  authorized  capitalization  according  to  the 
charter;  the  accounting  capital  less  retained  profits  or  i)lus 
deficit,  where  the  total  authorized  capitalization  is  out- 
standing, should  represent  the  amount  of  the  capital  stock. 

Practically  every  corporation  organized  for  profit  can  be 
classed  as  a  stock  corporation.  This  means  that  the  original 
capital  assumed  as  necessary  for  financing  the  business  is  raised 
principally  by  selling  shares  of  stock.  A  corporation's  capital 
stock  is  divided  into  a  number  of  equal  units,  each  unit  being 
called  a  "share";  a  share  of  stock,  therefore,  represents  a  pro- 
portionate interest  in  the  net  worth  of  a  corporation.  Each  one 
of  these  shares  may  or  may  not  have  a  specified  value;  if  the 
value  is  specified,  such  value  is  known  as  its  "par  value,"  whereas, 
if  no  value  is  specified,  the  stock  is  said  to  have  *'no  par  value." 
The  discussion  of  stock  with  no  par  value  is  reserved  for  a  later 
chapter.  Each  one  of  these  shares  may  have  a  face  (par)  value 
of  almost  any  amount,  depending  upon  the  laws  under  wliich 
the  corporation  is  organized.  Whatever  amount  the  par  value 
may  be,  this  must  be  uniform  for  all  the  shares  within  a  given 
class.  Usually,  the  par  value  is  $100.00,  although  frequently 
one  encounters  a  par  value  of  $10.00,  or  less ;  in  industrial  and 
mercantile  companies  the  par  value  usually  is  $100.00,  whereas, 
mining  companies  frequently  have  a  capital  stock  of  the  par 
vtvlue  of  $1.00.  In  New  York,  each  share  "shall  not  be  less  than 
five  nor  more  than  one  hundred  dollars."  (B.  C.  L.,  Art.  2.) 
Unless  some  excellent  reason  exists  for  so  doing,  it  is  advisable 
to  have  a  par  value  of  $100.00,  since  this  is  a  most  common  and 
convenient  unit  to  use.  At  any  rate,  the  par  value  of  any  issue 
of  stock  is  the  amount  specified  in  the  stock  certificate. 

Capital  Stock  Values. — It  may  be  said  that  each  share  of 
stock  has  four  values: 

1.  Par  or  nominal  value.  This  is  the  face  value  printed  some- 
where upon  the  face  of  each  stock  certificate.  The  par 
value  of  one  share  of  stock  is  equal  to  the  total  authorized 
issue  divided  by  the  number  of*  authorized  shares.    In  addi- 


CORPORATION^-OPENING  ENTRIES 


107 


tion  to  a  corporation  having  shares  of  stock  with  a  specified 
par  value,  certain  states,  as  New  York,  permit  stock  to  be 
issued  without  a  definite  par  value,  under  certain  conditions 
to  be  explained  later. 

2.  Book  value.  The  book  value  of  a  share  of  stock  is  repre- 
sented by  the  remainder  resulting  from  dividing  the  net 
worth  of  a  corporation  (capital  stock  plus  surplus,  or  minus 
deficit)  by  the  number  of  shares  of  stock  actually  issued 
and  outstanding.  When  a  corporation  is  organized,  it  is 
authorized  to  issue  a  limited  number  of  shares  of  a  stated 
value,  but  it  is  not  required  to  issue  all  such  shares  beyond 
the  legal  minimum  except  in  accord  with  the  desires  of  the 
corporate  officers  or  stockholders.  Book  value,  supposedly, 
should  be  ascertainable  from  the  Balance  Sheet. 

3.  Market  value.  The  market  value  of  a  share  of  stock  is  the 
price  it  will  yield  when  sold  upon  the  open  market.  This 
value  depends  primarily  upon  earning  capacity. 

4.  Real  value.  The  real  value  of  a  share  of  stock  is  the  amount 
which  its  holder  would  expect  to  receive  if  the  corporation 
were  liquidated.  The  real  value  of  a  share  of  stock  is  ascer- 
tained from  what  is  known  as  a  Statement  of  Affairs  (to 
be  discussed  in  a  later  chapter) ,  a  statement  in  which  the 
assets  are  valued  at  what  they  may  be  expected  to  realize, 
regardless  of  book  values. 

Primary  Classes  and  Kinds  of  Capital  Stock  With  Par 
Value :  Common  Versus  Preferred.— The  capital  stock  of  cor- 
porations may  be  divided  into  a  number  of  classes,  the  usual 
division  being  into  two  classes  as  follows: 

1.  Common  stock.  This  is  evidence  of  ordinary  ownership  in 
a  corporation.  It  has  no  financial  preference  or  special 
privileges  over  any  other  stock  of  the  company  and,  gen- 
erally, the  common  stockholders  are  those  which  have  the 
voting  power.  By  voting  power  is  meant  the  right  the 
stockholders  have  in  assisting  in  the  management  of  the 
company's  affairs  by  means  of  annually  electing  the  board 
of  directors,  the  latter  representing,  and  acting  for,  the 
general  body  of  stockholders  in  the  conduct  of  the  enter- 
prise. 


.,[/! 


108 


ADVANCED  ACCOUNTING 


I 


I.  11 


2.  Preferred  stock.  This  stock  is  entitled  to  first  consideration 
in  either  the  distribution  of  profits  or  assets,  or  both,  over 
other  stock  of  the  company.  As  compared  to  common  stock, 
it  has  been  given,  by  proper  procedure,  a  special  privilege 
of  some  kind  to  make  it  more  attractive  than  the  common 
stock  as  an  investment.  Unless  expressly  provided,  pre- 
ferred stock  has  no  preference  in  the  return  of  capital  upon 
liquidation.  Ordinarily,  the  preference  consists  in  an  agree- 
ment to  pay  a  definite  dividend  out  of  profits  before  any 
dividend  will  be  paid  upon  the  common  stock.  The  classes 
of  preferred  stock  may  be  listed  about  as  under: 

a.  Cumulative  as  to  dividends.  Preferred  stock  designates 
a  certain  minimum  rate  of  dividend,  but  if  the  net  profits 
of  the  company  are  not  suflScient  to  pay  the  dividend,  the 
preferred  stockholders  are  no  better  off  than  the  common 
stockholders.  However,  when  the  stock  is  designated  as 
cumulative,  each  unpaid  dividend  laps  over  into  the  next 
period  to  the  end  that  it  must  be  satisfied  from  the  profits 
of  succeeding  periods  before  the  owners  of  the  common 
stock  may  share  in  the  profits  at  all. 

b.  Non-cumulative  as  to  dividends.  Preferred  stock,  as  a 
rule,  is  cumulative  but  infrequently  it  may  not  be  so. 
Hereunder,  the  preferred  stockholders  will  not  receive  a 
dividend  for  the  current  period  unless  the  net  profits  are 
sufiicient  to  pay  the  rate  of  dividend  specified — may  be 
considered  as  non-participating  stock. 

c.  Entitle  holders  to  voting  power. 

d.  Not  entitle  holders  to  voting  power — non-voting  stock. 

e.  Redeemable  at  a  certain  price  on  or  before  a  date  speci- 
fied—redeemable stock.  Redemption  is  not  possible  if, 
by  such  action,  creditors'  interests  are  jeopardized. 
Convertible  into  some  other  form  of  corporate  ownership, 
or  obligation.  All  states  do  not  permit  a  conversion  into 
bonds  of  the  company. 

In  other  words,  a  great  variation  exists  in  the  kinds  of 
preferred  stock  that  may  be  issued.  Because  of  such  fact, 
it  is  advisable  to  make  certain  that  each  preferred  stock 
certificate  has  its  character  indicated  upon  its  face.  The 
lack  of  such  information  may  prove  disastrous  to  all  persons 


f. 


CORPORATIONS-OPENING  ENTRIES  109 

concerned;  courts  have  held  that  where  such  information 
is  lacking,  at  least  to  the  extent  of  reference  being  made 
therein  to  the  clauses  in  the  charter  authorizing  the  issue, 
the  preferred  stock  will  be  preferred  as  to  profits,  but  not 
be  preferred  as  to  anything  else. 
Preferred  stock  may  be  issued  at  the  time  of  the  organization 
of  the  company  and,  when  so  done,  the  common  stockholders  do 
not  need  to  authorize  its  issue.    However,  if  it  be  issued  subse- 
quent to  the  organization  of  the  company,  after  the  rights  of  the 
common  stockholders  have  been  established,  the   latter   must 
authorize  its  issue. 

The  following  is  the  New  York  law  relative  to  issuing  pre- 
ferred and  common  stock  (S.  C.  L.,  Art.  4) : 

Every  domestic  stock  corporation  may  issue  preferred  stock  and 
common  stock  and  diflFerent  classes  of  preferred  stock,  if  the  certificate 
of  incorporation  so  provides,  or 

1.  By  the  unanimous  consent  of  the  stockholders  expressed  m  writing 
and  filed  in  the  office  of  the  secretary  of  state  and  in  the  office  of 
the  clerk  of  the  county  in  which  the  principal  business  oflice  is 
located,  or 

2.  By  the  consent  of  the  holders  of  record  of  two-thirds  of  the  capital 
stock,  given  at  a  meeting  called  for  that  purpose  upon  notice  such 
a«  IS  requu-ed  for  the  annual  meeting  of  the  corporation.  A  cer- 
tificate of  the  proceedings  of  such  meeting,  .  shall  be 
filed  and  recorded  in  the  oflices  where  the  original  certificate  of 
incorporation  of  such  corporation  was  filed  and  recorded. 

Preferred  stock,  usually,  is  issued  to  provide  a  corporate  secu- 
rity  which  is  more  readily  salable  than  common  stock  But 
because  of  its  numerous  possible  variations,  preferred  stock  is 
available  for  other  purposes: 

1.  It  may  represent  or  be  used  to  pay  for  the  actual  value 
of  the  properties  taken  over  by  a  new  company,  whereas,  the 
common  stock  may  be  used  to  represent  good-will  and  other 
mtangible  properties. 

2.  In  the  incorporation  of  an  existing  partnership,  non-voting 
preferred  stock  may  be  issued  to  cover  the  excess  investment 
of  one  of  the  partners,  and  to  take  care  of  the  interest  of 
a  silent  partner. 

3.  In  a  consolidation  of  properties,  preferred  stock  may  be  used 
m  adjusting  the  interests  of  all  parties  equitably.     It  is 


■A. 


f^ 


I 


,1 


i 


i 


110  ADVANCED  ACCOUNTING 

believed,  however,  that  (1)  above  is  to  bo  preferred  to  (3) 
in  every  way. 

4.  It  may  be  used  as  a  means  of  raising  money  rather  than 
doing  so  by  an  issue  of  bonds.  Not  only  are  bonds  an 
absolute  obligation  both  as  to  interest  and  principal,  but 
they  must  be  paid  upon  maturity  without  regard  to  the  then 
existing  condition  of  finances,  under  penalty  of  foreclosure; 
preferred  stock,  at  least,  is  only  a  claim  against  profits, 
being  neither  a  debt  as  to  dividends  nor  a  debt  as  to  prm- 
cipal.  If  the  stock  is  not  redeemable,  it  is  never  due  as  to 
principal 

Sundry  Classes  and  Kinds  of  Capital  Stock  With  Par 
Value. — There  are  many  classes  of  stock  other  than  the  two 
usual  kinds  mentioned  above.  These  are  described  briefly  as 
follows: 

1.  Guaranteed  stock.  This  stock,  usually,  is  issued  under  a 
guaranty  by  some  person,  concern,  or  corporation,  that  a 
specific  dividend  will  be  paid  thereon.  Since  dividends  cnn 
be  declared  only  out  of  profits,  a  company  cannot  guarantee 
its  own  stock  except  upon  the  condition  that  profits  have 
been  earned  sufficient  for  that  purpose.  However,  one  com- 
pany may  guarantee,  under  contract,  a  certain  dividend  to 
the  holders  of  the  stock  of  another  company,  say,  a  smaller 
one.  Such  a  guaranty  is  not  contingent  upon  the  earning 
of  profits,  but  is  a  lien  against  the  giiarantor  company 
regardless  of  what  the  amount  of  the  earning  of  the  latter 
company  may  be;  it  is  an  actual  obligation  to  be  met  wlien 
due,  exactly  as  any  other  interest  or  obligation.  Sometimes 
the  term  is  used  in  connection  with  preferred  stock  on  which 
dividends  are  guaranteed  by  the  action  which  created  the 
issue.  Such  guaranteed  preferred  stock  merely  is  cumula- 
tive preferred  stock;  since  a  dividend  must  be  paid  from 
profits,  no  debt  is  created  if  profits  are  not  sufficient  to  cover 
such  dividend.  The  unpaid  dividends  cumulate  as  a  charge 
against  future  profits.  Again,  the  guarantee  may  cover  the 
principal,  or  both  dividend  and  principal. 

2.  Founders'  stock.  This  is  an  English  type  of  stock  issue,  not 
found  in  the  United  States.     This  stock  has  a  dividend 


CORPORATIONS— OPENING  ENTRIES 


111 


preference  which  may  cause  its  market  value  to  rise  con- 
siderably beyond  that  of  other  stock.  It  consists  of  a  cer- 
tain small  portion  of  the  common  stock  which  has  been  set 
aside  for  the  founders  or  promoters  of  the  company  and 
labeled  ''founders'  stock,"  rather  than  being  an  issue  of 
preferred  stock  with  a  dividend  preference.  The  dividends 
upon  this,  small  portion  of  set-aside  common  stock  are 
greater  than  the  ratio  their  amount  bears  to  the  whole 
regular  stock  issue. 

3.  Debenture  stock.  This  is  a  term  applied  in  England  to  a 
class  of  liabilities  and  not  to  anything  signifying  net  worth 
or  proprietorship.  It  represents  "an  unsecured  loan  issued 
in  irregular  amounts."  Debenture  stock  is  in  the  nature  of 
bonds,  and  rightly  might  be  called  "debenture  bonds"  were 
the  issues  made  in  regular,  instead  of  in  irregular,  amounts. 
The  Public  Service  Commission  of  New  York  defines  deben- 
ture stock  as  "those  issued  under  contract  to  pay  absolutely 
thereon  at  specified  intervals  a  specified  return."  Deben- 
ture stock  is  not  much  made  use  of  in  the  United  States, 
although  common  in  Canada.  If  found,  it  should  be  classed 
as  a  liability. 

4.  Watered  stock.  This  has  a  higher  nominal  value  than  the 
properties  for  which  it  has  been  issued.  If  $50,000,  par 
value,  of  stock  is  issued  for  assets  which  only  have  a  market 
value  of  $40,000,  the  stock  contains  $10,000  of  "water." 
Since  the  accounting  records  must  show  the  par  value  of 
the  stock  issued,  it  is  necessary  to  keep  the  basic  accounting 
equation  in  balance,  to  offset  the  credit  of  $50,000  to  the 
Capital  Stock  account  by  a  debit  of  an  equal  amount  to 
certain  other  accounts.  Usually,  these  other  accounts  are 
those  kept  with  the  properties  taken  over,  the  values  of 
the  latter  being  therein  recorded  at  an  inflated  amount  of 
$10,000.  The  issue  of  this  stock  may  be  entirely  justifiable 
and,  again,  its  issuance  rightly  may  be  condemned.  In  the 
above  case,  if  a  going  concern  were  incorporated,  and  for 
a  number  of  years  past  its  earnings  were  such  that  it  is 
reasonable  to  believe  earnings  are  sufficient  to  pay  a  divi- 
dend upon  a  capitalization  of  $50,000,  the  inflation  would 
seem  to  be  justifiable  and  proper.     On  the  other  hand,  if 


t 


112 


ADVANCED  ACCOUNTING 


CORPORATIONS— OPENING  ENTRIES 


113 


r 


the  capitalization  were  far  beyond  both  the  value  of  the 
properties  and  any  earning  power  possessed,  the  water  in 
the  stock  would  not  be  justifiable  and  proper;  the  "water'' 
would  be  the  excess  of  nominal  value  over  real  value. 
5.  Forfeited  stock.    This  is  stock  which  is  forfeited  by  order 
of  the  board  of  directors  by  failure  of  those  who  have 
promised  to  buy  at  a  certain  price  refusing  to  make  good 
the  agreed  purchase  payments.    State  laws  differ  markedly 
in  regard  to  forfeited  stock.    Sometimes  the  amounts  paid 
in  must  be  returned  to  the  persons  who  have  made  the  pay- 
ments; again,  the  amounts  paid  in  n^ed  not  be  returned. 
Forfeiture  only  is  possible  where  the  statutes  specifically 
grant  such  power.    When  the  right  is  exercised,  it  should 
be  for  the  benefit  of  the  corporation,  not  for  the  benefit  of 
the  stockholder  or  stockholders.     The  New  York  law  on 
this  subject  is  as  follows   (S.  C.  L.,  Art.  4) :  **If  default 
shall  be  made  in  the  payment  of  any  instalment  as  re- 
quired   ,  the  board  may  declare  the  stock  and  all 

previous  payments  thereon  forfeited  for  the  use  of  the 
corporation,  after  the  expiration  of  sixty   days  from  the 

service  on  the  defaulting  stockholder Such  stock, 

if  forfeited,  may  be  reissued  or  subscriptions  therefor  may 
be  received  as  in  the  case  of  stock  not  issued  or  subscribed 
for.  If  not  sold  for  its  par  value  or  subscribed  for  within 
six  months  after  such  forfeiture,  it  shall  be  canceled  and 
deducted  from  the  amount  of  the  capital  stock."  In  event 
of  forfeiture,  the  corporation  makes  a  profit  which  must  be 
shown  upon  the  books  of  account. 

6.  Treasury  stock.  This  is  stock  that  has  been  issued  as  fully 
paid,  in  due  form,  has  then  been  reacquired,  and  is  held  by 
the  company  subject  to  the  wishes  of  the  directors  as  regards 
its  disposition.    Further  will  be  said  on  this  subject  later. 

7.  Donated  stock.  This  is  stock  that  has  been  issued  as  fully 
paid,  in  due  form,  and  which  has  been  handed  back  to  the 
company  as  a  gift.  When  this  stock  is  taken  up  on  the 
books,  it  is  recorded  as  treasury  stock. 

8.  Bonus  stock.  Any  stock  issued  as  a  gift  to  purchasers  of 
preferred  stock  or  bonds  is  bonus  stock.  Usually,  bonus 
stock  is  treasury  stock  because,  otherwise,  the  recipient 


9 


would  be  liable  for  the  par  value  oi  such  stock.  However, 
bonus  stock  may  be  unissued  stock  and  no  liability  for  its 
par  value  will  be  incurred,  provided  certain  conditions  are 
encountered.  In  New  York,  unissued  stock  may  be  issued 
as  a  bonus  where  necessary  to  float  a  bond  issue  success- 
fully (106  N.  Y.,  97).  Again,  such  bonus  is  proper  in  the 
case  of  floating  a  bond  issue  where  the  par  value  of  the 
bonds  is  greater  than  the  actual  value  of  the  bonds  plus  the 
stock  (139  U.  S.,  417). 

Canceled  stock.  Shares  of  stock  that  have  been  declared 
canceled,  i.  e.,  void,  the  result  being  to  reduce  the  number 
of  shares  the  company  can  issue. 

10.  Outstanding  stock.  Stock  issued,  and  outstanding  in  the 
hands  of  the  public. 

11.  Authorized  stock.  The  total  amount  of  stock,  or  shares  of 
stock,  which  a  corporation,  under  its  charter,  has  authority 
to  issue. 

12.  Unissued  stock.  The  total  amount  of  stock,  or  shares  of 
stock,  for  which  stock  certificates  have  not  been  issued.  No 
obligation  rests  upon  a  corporation  to  issue  the  full  amount 
of  its  authorized  issue.  After  the  statutory  requirements 
governing  the  minimum  amount  of  stock  issue  have  been 
complied  with,  the  company  may  do  whatever  it  pleases 
with  the  remaining  amount  so  far  as  issuance  is  concerned. 
In  reality,  unissued  stock  is  merely  the  right  to  issue  stock 
(a  potentiality) ;  by  itself,  it  has  no  value,  and  neither  can 
be  voted  nor  participate  in  dividends.  Unissued  stock  is 
not  treasury  stock,  as  some  would  have  us  believe.  How- 
ever, if  stock  certificates  (see  post)  have  been  detached  from 
their  stubs  in  the  stock  certificate  book  (see  post),  have 
been  signed,  sealed,  assigned  in  blank,  and  have  been  placed 
with  transfer  agents  or  others  for  sale  and  delivery,  the 
shares  represented  should  be  booked  both  as  an  asset  and 
as  a  liability. 

13.  Unsubscribed  stock.    Unissued  stock  for  which  no  subscrpi- 
tion  has  been  received. 

Capital  Stock  Issuance  and  Mode  of  Payment.— The  capital 
stock  of  a  corporation  is  issued  for  a  consideration  of  some  sort, 


114 


ADVANCED  ACCOUNTING 


^ 


the  nature  of  which  is  found  to  vary  under  the  different  statutefs. 
In  general,  it  may  be  said  that  the  consideration  may  be: 

1.  Cash  or  its  equivalent,  including  subscriptions  that  are 
subject  to  call. 

2.  Labor  or  services,  including  both  manual  and  brain  effort. 

3.  Property,  at  a  valuation  to  be  fixed  by  the  board  of  directors. 
In  this  connection,  note  the  New  York  law  (8.  C.  L.,  Art.  4) : 

No  corporation  shall  issue  either  stock  or  bonds  except  for  monry, 
labor  done  or  property  actually  received  for  the  use  and  lawful  purposes 
of  such  corporation.  Any  corporation  may  purchase  any  property 
authorized  by  its  certificate  of  incorporation,  or  n«'cessary  for  the  Uf<e 
and  lawful  purposes  of  such  corporation,  and  may  issue  stock  to  the 
amount  of  the  value  thereof  in  payment  therefor,  and  the  stock  so 
issued  shall  be  full  paid  stock  and  not  liable  to  any  further  call,  neither 
shall  the  holder  thereof  be  liable  for  any  further  jiayment  under  any 
of  the  provisions  of  this  chapter;  and  in  the  absence  of  fraud  in  the 
transaction  the  judgment  of  the  directors  as  to  the  value  of  the  pro[)- 
erty  purchased  shall  be  conclusive;  and  in  all  statements  and  reports 
of  the  corporation,  by  law  required  to  be  published  or  filed,  this  stock 
shall  not  be  stated  or  reported  as  being  issued  for  cash  paid  to  the  cor- 
poration, but  shall  be  reported  as  issued  for  property  purchased. 

Fully  Paid  and  Partly  Paid  Capital  Stock. — In  general,  a 
corporation  may  sell  its  stock  for  any  fair  price  and,  when  this 
price  has  been  collected,  it  has  no  further  claim  against  the 
buyer;  but: 

1.  If  this  agreed  price  is  less  than  the  face  value  of  the  stock, 
it  is  not  fully  paid  and,  in  case  of  insolvency,  the  corporate 
creditors  could  force  the  original  purchasers,  who  then  hold 
any  of  the  stock,  to  pay  over  the  difference  between  the 
purchase  price  and  the  par  value,  or  whatever  portion  of 
this  difference  is  needed  to  discharge  the  corporate  liabili- 
ties.   Such  a  sale  would  be  illegal  in  New  York. 

2.  If  this  stock  is  sold  for  full  face  value,  payments  thenjon 
to  be  made  in  installments,  and  these  installments  have  not 
been  all  paid,  the  buyers  would  be  liable  either  to  the  cor- 
poration or  to  its  creditors  for  the  balance  due. 

As  to  capital  stock  not  fully  paid,  the  New  York  law  states 
(S.  C.  L.,  Art.  4) : 

Every  holder  of  capital  stock  not  fully  paid,  in  any  stock  corpora- 
tion, shall  be  personally  liable  to  its  creditors,  to  an  amount  equal  to 


CORPORATIONS-OPENING  ENTRIES  115 

the  amount  unpaid  on  the  stock  held  by  him  for  debts  of  the  corpora- 
tion contracted  while  such  stock  was  held  by  him. 

Stock  Subscriptions.— Capital  stock  subscriptions  are  en- 
forceable promises  in  writing,  made  by  persons  who  contemplate 
becommg  stockholders  in  a  corporate  enterprise,  to  pay  on  a 
.  eertam  date  or  dates,  or  upon  call  or  demand,  an  amount  usually 
equal  to  the  par  value  of  the  number  of  shares  purchased  Only 
after  a  certain  number  of  shares  have  been  subscribed  for  and 
a  certain  amount  thereon  paid  in,  in  cash,  nroperty  or  services 
can  the  corporation,  as  such,  commence  business 

The  New  York  requirements  of  interest  in  this  connection  are 
as  follows  (S.  C.  L.,  Art.  4) : 

If  the  whole  capital  stock  shaU  not  have  been  subscribed  at  the 
time  of  filing  the  certificate  of  incorporation,  the  directors  named  in 
the  certificate  may  open  books  of  subscription  to  fill  up  the  capital 
stock  in  such  places  and  after  giving  such  notice  as  they  deem  expe- 
dient, and  continue  to  receive  subscriptions  until  the  whole  capital 

whose  "  ^:"'""'^^:  ^*  *^^  .^-^  -^  subscribing,  every  subscrfber, 
whose  subscription  is  payable  m  money,  shall  pay  to  the  directors  ten 
per  centum  upon  the  amount  subscribed  by  him  in  cash,  and  no  such 
subscription  shall  be  received  or  taken  without  such  payment 
feubscriptions  to  the  capital  stock  of  a  corporation  shall  be  paid  at  such 
times  and  m  such  instalments  as  the  board  of  directors  may  by  resolu- 
tion requu-e.  ^  ^^oum 

In  New  York,  therefore,  one  may  assume  that  stock  cannot  be 
issued  at  a  discount.  The  company  must  receive  in  exchange 
for  stock  issued  the  par  value  of  the  stock  in  cash,  and  if  prop- 
erty or  services  are  received  therefor,  the  latter  must  be  worth 
m  the  discreet  judgment  of  the  board  of  directors  of  the  corpora- 
tion, the  par  value  of  the  stock  issued  therefor. 

When  the  final  stock  subscriptions  have  been  paid,  and  possibly 
before  their  full  payment,  an  allotment  takes  places  by  means 
01  which  the  subscribers  to  the  capital  stock  are  determined  upon 

In  general,  an  unconditional  subscription  to  the  stock  of  a 
corporation  is  binding  upon  the  subscriber  to  the  end  that  either 
the  company  itself  may  enforce  payment  thereunder,  or  the  cor- 
poration creditors,  upon  insolvency,  may  do  so.  However,  where 
the  statutes  require  that  a  certain  per  cent  of  the  subscriptions 
must  be  paid  m  in  cash  at  the  time  of  subscribing,  such  a  pay- 


I  ^,- 


116 


ADVANCED  ACCOUNTING 


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ment  must  be  made  before  the  subscription  ran  be  enforced. 
As  soon  as  a  corporation  accepts  a  subscription,  the  subscriber 
becomes  a  stockholder  of  the  company. 

Stock  Certificates. — The  interest  of  a  stockholder  in  a  cor- 
poration is  evidenced  in  two  ways: 

1.  Certain  entries  upon  the  corporate  books. 

2.  A  certificate  or  certificates  signed  and  sealed  by  the  proper 
corporate  officials  showing  the  number  of  shares  owned  by 
the  person  or  company  to  whom  the  certificate  or  certificates 
is  or  are  issued,  the  par  of  such  shares,  and  the  total  number 
of  shares  of  the  corporation. 

By  having  his  name  entered  in  due  and  regular  form  upon  the 
corporate  books,  a  stockholder  is  said  to  be  an  "owner  of  record." 
There  are  two  separate  and  distinct  corporation  certificates: 

1.  Incorporation  certificate.  In  effect,  this  performs  the  func- 
tions of  a  specially  granted  charter,  as  has  been  shown 

above. 

2.  Stock  certificate.  The  certificate  is  not  the  stock  itself,  but 
is  the  evidence  of  the  ownership  of  the  number  of  shares 
therein  certified  to.  The  owner  or  holder  of  a  stock  certifi- 
cate is  a  stockholder,  endowed  with  the  rights,  privileges, 
duties  and  other  incidents  pertaining  to  the  relation  (40 
How.,  196). 

Every  stockholder  is  entitled  to  a  certificate  as  written  evi- 
dence of  his  ownership  of  a  certain  amount  of  capital  stock. 
Under  certain  conditions,  he  could  force  such  a  certificate  to  be 
issued  to  him.  However,  actual  possession  of  a  certificate  of 
stock  is  not  necessary  to  complete  ownership,  nor  is  it  essential 
to  the  existence  of  a  corporation  that  any  certificates  be  named 
at  all  (22  N.  Y.,  551).  A  certificate  of  stock  is  only  a  convenient 
voucher  (40  How.,  196),  merely  the  symbol  or  paper  evidence 
of  property;  hence,  the  proprietary  right  may  exist  without  tlie 
certificate  (Thompson  on  Corporations).  As  evidence  of  the 
ownership  of  a  certain  number  of  shares  of  stock,  the  stockholder 
may  have  one  certificate  to  cover;  or  he  may  have  a  number  of 
them,  each  such  certificate  representing  a  portion  of  his  total 
holdings. 

By  general  mercantile  usage,  shares  in  a  corporation  are  assignable 
by  indorsements  and  delivery  of  the  certificates  issued  to  the  owner 
as  evidence  of  his  rights.     (Morawetz  on  Corporations). 


CORPORATIONS-OPENING  ENTRIES  117 

Whatever  contributes  to  make  a  share  of  stock  a  safe  mode  of 
mvestment  and  easily  convertible  tends  to  enhance  its  value. 

It  is  no  less  the  interest  of  the  shareholders  than  the  public  that  the 
certificate  representing  his  stock  should  be  in  a  form  to  secure  public 
confidencMor  without  this  he  could  not  negotiate  it  to  any  advantage 
It  IS  m  obedience  to  this  requirement  that  stock  certificates  of  all  kinds 
have  been  constructed  in  a  way  to  invite  the  confidence  of  business  men 

L  lal  r  '7,^^^"^^  *^^  ^--  -f  —ercial  transactions  in  ali 
the  large  cities  of  the  country  and  are  sold  in  the  open  market  as  other 
securities;  although  neither  in  form  nor  charactef  negotiable  paj^^^^ 
they  approximate  It  as  nearly  as  practicable.   .    .  No  better  W 

could  be  adopted  to  assure  the  purchaser  that  he 'can  buy  ^th  s  jety 
He  IS  to  d  under  the  seal  of  the  corporation  that  the  Lreho  der  Is 
entitled  to  so  much  stock,  which  can  be  transferred  on  the  books  o 
the  corporation,  m  person  or  by  attorney,  when  the  certificates  are 
surrendered,  but  not  otherwise.     This  is  a  notification  to  aU  ^  so"s 

itTtolh  "  T  "k''""  '"^  ^^^^  ^^^*^  b"^'^  the  stock  a" 

duces  to  the  corporation  the  certificates,  regularly  assigned,  with  rZer 
to  transfer,  is  entitled  to  have  the  stock  transferred  to  hirk.  AndThe 
notification  goes  further,  for  it  assures  the  holder  that  the  corp^rl^^^^^ 

^:'V^t^^r'" "  ™^  ^"  '"^  ^'--'-^  '^  ^^ 

A  stock  certificate  may  become  lost  or  destroyed.     Whether 
or  not  such  loss  or  destruction  will  have  an  adverse  effect  upon 

stance?         '  '  ''"'  "  ^""'^^^  ^^^^"^^  ^^^  -- '" 

1.  If  the  stockholder  is  the  owner  of  record.  The  loss  or 
destruction  will  not  affect  ownership.  Since  he  is  still  the 
owner  of  record  on  the  corporate  books,  he  is  entitled  to  all 
nis  rights  as  formerly; 

a.  To  receive  dividends. 

o   t;  Ju    *?  '^'■f' ?*  ''"'^  """^  ^*  stockholders'  meetings. 

2.  If  tiie  stockholder  purchased  his  stock  from  one  who  is  the 
owner  of  record,  but  has  not  had  an  opportunity  to  have 
such  recorded  ownership  transferred  to  himself.    The  situ- 

boultTh  ''f  t  T*  ''"°"'  "'*'"'"•  W^^«  *he  purchaser 
bought  the  stock,  the  certificate  or  certificates  in  question 
would  be  transferred  to  him  by  assigmnent.  Since  such 
a  signment  IS  made  only  on  the  back  of  the  certificates  in 

.Zn  r'  u  'Ti"^*'  ^"^  ^'"  ''^^^  °»  'ecord  thereof 
until  the  old  certificates  are  surrendered.    According  to  the 


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corporate  books,  the  vendor  will  be  the  owner  of  record,  not 
the  vendee.  And  it  may  be  a  difficult  matter,  should  the 
vendor  be  unscrupulous,  for  the  vendee  to  establish  his  true 
status. 

If  the  owner  of  record  has  lost  his  certificat(%  and  wishes  to 
sell  his  stock,  it  would  be  well-nigh  impossible  for  him  to  do  so; 
very  few  persons  would  be  foolish  enough  to  purchase  stock 
without  a  transfer  of  the  certificates  involved.  It  is  natural  to 
assume  that  the  vendor  first  would  have  to  secure  a  new  certifi- 
cate (a  reissue),  and  to  secure  such  it  would  be  necessary  for 
him  to  give  a  bond  to  the  corporation  to  protect  the  latter  in 
the  event  that  the  lost  original  certificate  turned  up  in  the  hands 
of  an  innocent  holder  for  value.  In  general,  by  the  operation  of 
the  law  of  estoppel  the  purchaser  of  a  certificate  of  stock,  in  good 
faith  and  for  value,  may  take  it  free  from  any  claims  of  previous 
holders,  which  would  be  allowed  to  come  in,  in  the  case  of  a  sale 
of  an  ordinary  chose  in  action  (79  Fed.  Rep.,  228). 

As  to  lost  or  destroyed  certificates  of  stock,  the  New  York  law 
states  as  follows  (S.  C.  L.,  Art.  4,  sees.  67-68) : 

The  owner  of  a  lost  or  destroyed  certificate  of  stork,  if  the  corpora- 
tion shall  refuse  to  issue  a  new  certificate  in  place  thereof,  may  apply 
to  the  supreme  court,  at  any  special  term  held  in  the  district  where  he 
resides,  or  in  which  the  principal  business  office  of  the  corporation  is 
located,  for  an  order  requiring  the  corporation  to  show  cause  why  it 
should  not  be  required  to  issue  a  new  certificate  in  place  of  the  one  lost 
or  destroyed.  The  application  shall  be  by  petition,  duly  verified  by 
the  owner,  stating  the  name  of  the  corporation,  the  number  and  date 
of  the  certificate,  if  known,  or  if  it  can  be  ascertained  by  the  petitioner; 
the  number  of  shares  named  therein,  to  whom  issued,  and  as  particular 
a  statement  of  the  circumstances  attending  such  loss  or  destruction  as 
the  petitioner  can  give.  Upon  the  presentation  of  the  petition  the 
court  shall  make  an  order  requiring  the  corporation  to  show  cause 

Upon  the  return  of  the  order,  with  proof  of  due  service 

thereof,  the  court  shall inquire  into  the  truth  of  the  facts 

stated  in  the  petition,  and if  satisfied it  shall 

make  an  order  requiring  the  corporation,  within  such  time  as  shall 
be  therein  designated,  to  issue  and  deliver  to  the  petitioner  a  new 
certificate  for  the  number  of  shares  specified  in  the  order,  upon  deposit- 
ing such  security,  or  filing  a  bond  in  such  form  and  with  such  sureties 
as  to  the  court  shall  appear  sufficient  to  indemnify  any  person  othef 
than  the  petitioner  who  shall  thereafter  be  found  to  be  the  lawful 
owner  of  the  certificate  lost  or  destroyed 


CORPORATIONS-OPENING  ENTRIES  ng 

Stock  Ledger.-In  most  states,  the  law  specifies  that  the 
capital  stock  outstanding  shall  be  shown  in  detail  in  a  record 
known  as  a  Stock  Ledger.     Under  all  circumstances,  such  a 
record  is  necessary  when  the  stockholders  are  numerous      An 
account  is  carried  in  the  Stock  Ledger  with  each  stockholder 
Each  such  account  is  credited  with  the  par  value  of  the  stock 
issued  to  the  stockholder  whose  name  is  the  title  of  such  account 
and  It  IS  charged  with  all  transfers  made;  when  each  such  trans- 
fer is  made,  the  transferee's  account  must  be  credited     The  bal 
ance  of  each  account  should  show,  at  all  times,  the  par  value  of 
the  holdings  of  the  stockholder  whose  name  appears  as  the  head- 
mg  of  such  account. 

Separate  Stock  Ledgers  are  kept  for  each  class  of  capital  stock 
if  the  amount  of  work  necessary  in  connection  with  the  keepin<^ 
of  the  Stock  Ledger  is  large,  a  Trust  Company,  usually,  is  ap! 
pointed   to^  take   over   these   duties;   such    company   is   titled 
registrar. 

Each  such  Ledger  is  made  self-balancing  by  including  thereon 
an  account  with  Capital  Stock,  which  is  in  the  nature  of  a 
control,  and  which  holds  as  a  debit  balance  the  net  total  of  the 
outstanding  balances  carried  as  credits  in  each  of  the  detail 
accounts.  Such  controlling  account  articulates  with  the  account 
ot  Capital  Stock  carried  on  the  general  or  primary  Ledger 
ch^ter  """'  ^^  '^'"^  concerning  this  record   in   a  subsequent 

Opening  Entries—The  question  of  opening  entries  seems  to 
sh.Zt''  Tt''"''u  •^°"^'^«'-^ble  trouble  for  a  large  number  of 
studen  s.  This,  perhaps,  is  due  both  to  the  fact  that  accountants 
are  not  uniform  in  respect  thereto,  and  that  the  account  titles 
used  are  not  accepted  exactly  as  meaning  what  apparently  the 

sTi\  '°  T'"  '"'*''^*^-  ^^^'^^l'^'  '-  account  title 
should  be  as  clearly  expressive  of  the  items  thereunder  to  be 
accumulated  as  it  is  possible  to  make  it 

For  purposes  of  illustration,  a  number  of  varying  conditions 
will  be  presented,  for  each  of  which  an  opening  entry  will  be 
iramed;  at  times,  more  than  one  solution  will  be  given  These 
variations  may  be  set  out  as  follows: 

1.  Stock  issued  for  money  only:  fully  subscribed-^ne  class. 

2.  Stock  issued  for  money  only:  partly  subscribed-more  than 
one  class. 


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CORPORATIONS— OPENING  ENTRIES 


121 


1 


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3.  Stock  issued  for  cash  on  the  installment  plan:   fully  sub- 
scribed. 

4.  Stock  issued  for  both  money  and  notes:  partly  subscribed, 

5.  Stock  issued  for  property  or  for  cash  and  property. 

6.  Issue  of  no  par  value  stock. 

7.  Transfer  of  a  sole  trader's,  or  of  a  partnership,  business  to 
a  corporation. 

Illustrations  relative  to  the  first  four  possibilities  will  be  pre* 
sented  in  the  remaining  portion  of  this  chapter,  and  illustrations 
covering  the  remaining  three  variations  will  be  reserved  for  th(^ 
next  chapter. 

Stock  Issued  for  Money  Only:  Fully  Subscribed — One 
Class. — The  entire  capital  stock  of  a  corporation  may  be  sub- 
scribed and  paid  for  in  cash.  Such  condition  is  a  simple  one, 
and  presents  no  difficulties.  After  the  certificate  of  incorporation 
has  been  accepted,  a  record  thereof  usually  is  made  in  what  is 
known  as  the  Minute  Book ;  this  record  will  be  described  in  more 
detail  at  a  later  time.  The  entry  of  the  incorporation  certificate 
upon  the  Minute  Book  may  be  made  after  the  first  organization 
meeting  is  held,  or  it  may  be  made  before  that  meeting  takes 
place.  When  the  subscriptions  have  been  paid  in,  stock  certifi- 
cates are  issued  to  the  stockholders.  Each  stockholder  may  have 
one  certificate  issued  to  him  covering  his  total  holdings,  or  he 
may  have  a  number  of  them  issued  to  him,  each  representing  a 
portion  of  his  holdings.  Usually,  however,  it  will  be  found  that 
no  certificate  will  be  issued  for  more  than  100  shares  unless  the 
corporation  is  not  listed  upon  the  Stock  Exchange.  After  the 
stock  certificates  have  been  issued,  the  Stock  Ledger  is  opem^d, 
each  stockholder  being  given  an  account  therein.  If  the  opening 
entries  have  not  been  made  prior  to  this  time,  they  should  be 
considered  next.  This  is  accomplished  usually  by  means  of  an 
opening  entry  in  the  Journal,  such  entry  being  made  upon  a 
regular  bound  book  or  upon  a  Journal  voucher,  as  the  case  may 
be.  Such  opening  entry,  as  in  the  case  of  a  sole  trader  or  part- 
nership, is  preceded  by  a  brief  statement  containing  items  of 
interest  concerning  the  corporation,  as  name,  object,  capitaliaa- 
tion,  number  of  shares,  names  of  incorporators,  etc. 

Problem. — The  Bixby  Company  was  incorporated  January  2,  1920,    with 
an  authorized  capital  stock  issue  of  $100,000.00,  each  share  of  the  par  value 


100,000.00 


100,000.00 


of  $100.00,  the  subscribers  being  as  follows:  George  Lacey,  200  shares; 
John  Ball,  500  shares;  and  Ray  Smith,  300  shares.  AU  the  stock  was  sub^ 
scribed  and  paid  for  in  cash. 

Solution.— In  every  instance,  the  opening  corporate  entries  depend  upon 
the  facts  of  the  case  in  hand,  upon  the  legal  requirements  of  the  state  in 
which  the  company  is  incorporated,  and  the  ideas  of  the  person  making  them. 

THE  BIXBY  COMPANY 

Incorporated  Under  the  Laws  of  the  State  of  New  York 

With  an  Authorized  Capital  Stock  of 

$100,000.00 

Divided  into  1,000  Shares 

Par  Value  $100.00 

January  2,  1920 

Subscriptions, 
To— Capital  Stock, 

To  record  authorized  issue  and  subscrip- 
tions made  therefor,  as  shown  by  sub- 
scription list 

Date 
Cash, 

To-Subscriptions,  100 ,  000 .  00 

To  record  cash  received  m  payment  of  stock  subscribed,  as  follows: 

George  Lacey,  200  shares 

John  Ball,  500  shares 

Ray  Smith,  300  shares 

Total,  1,000  shares 

Entry  made  in  Cash  Book. 
The  general  records  do  not  show  the  capital  stock  held  by  each  stock- 
holder. The  capital  stock  issued  appears  in  one  account  only,  as  indicated 
above.  The  interests  of  the  various  stockholders  are  shown  in  detail  upon 
the  btock  Ledger.  The  cash  item,  assuming  the  above  entries  were  made 
upon  the  Journal  in  the  first  instance,  would  be  transferred  to  the  Cash 
Book  and  from  there  be  posted  to  the  Ledger  account  of  Cash. 

Stock  Issued  for  Money  Only:  Partly  Subscribed— More 
Than  One  Class.— The  capital  stock  of  a  corporation  may  be  of 
more  than  one  class;  usually,  when  this  condition  is  encountered, 
the  classes  will  consist  of  common  and  preferred  stock.  Like- 
wise, all  the  stock  may  not  be  subscribed  for  in  full,  or  be  all 
paid  in  in  cash.  In  this  connection,  it  is  possible  to  digress  from 
the  simple  opening  entry  shown  above,  and  use  one  or  two  other 


100,000  00 


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i 


■^ 


methods  of  booking  the  issue.  In  fact,  corporate  records  may 
be  opened  in  a  number  of  ways,  under  almost  all  conditions. 
Naturally,  the  governing  factor,  in  every  case,  is  to  have  the 
opening  entry  record  actual  facts  and  to  have  the  result  of  such 
opening  entry  stated  correctly. 

Problem.— The  Bixby  Company  was  incorporated  on  January  2,  1920, 
with  an  authorized  capital  stock  issue  of  $100,000.00,  divided  into  $50,000.01) 
preferred  stock  and  $50,000.00  common  stock,  par  value,  $100.00  per  share. 
The  incorporators  subscribed  and  paid  for  $20,000.00  of  the  common 
stock,  and  $30,000.00  of  the  preferred  stock  was  sold  to  the  general  public; 
for  cash,  the  cash  being  paid  in. 

Solution  No.  1.— The  formal  heading  is  omitted.  The  entries  are  as 
follows: 


January  2,  1920 

Subscribers, 

To — Subscriptions, 

To   record   subscriptions   of   incorporators 

who  agree  to  take  200  shares  common 

stock 

Date 
Cash, 

To — Subscribers, 

To  record  payment  of  subscriptions  by  in- 
corporators 

Date 
Subscriptions, 
To — Capital  Stock — Common, 

To  record  issue  of  stock  to  incorporators 

Date 
Cash, 

To — Capital  Stock — Preferred, 

To  record  sale  of  300  shares  of  preferred 
stock  to  sundry  persons. 


20,000.00 


20,000.00 


20,000.00 


20,000.00 


20,000.00 


20,000.00 


30,000.00 


30,000.00 


Solution  No.  2.— The  formal  heading  is  omitted.     The  entries  are  at 
follows: 


Date 
Unissued  Capital  Stock— Perferred, 
Unissued  Capital  Stock — Common, 

To — ^Authorized  Capital  Stock — Preferred, 

Authorized  Capital  Stock— Common, 

To  place  authorized  issue  on  books. 


50,000.00 
50,000.00 


50,000.00 
50,000.00 


CORPORATIONS— OPENING  ENTRIES 


123 


20,000.00 


20,000.00 


20,000.00 


20,000  00 


20,000.00 


20,000.00 


Date 

Subscribers  to  Capital  Stock — Common, 

To — Subscriptions  to  Capital  Stock — Common, 
To  record  subscriptions  of  incorporators  for 
200  shares. 

Date 

Cash, 

To — Subscribers  to  Capital  Stock — Common, 

To  record  payment   by  incorporators  for 

their  subscriptions  to  the  common  stock. 

Date 

Subscriptions  to  Capital  Stock — Common, 
To — Unissued  Capital  Stock — Common, 
To  record  issue  of  200  shares  of  common 
stock  to  incorporators 

Date 
Cash, 

To — Unissued  Capital  Stock — Preferred, 
To  record  sale  of  300  shares  of  preferred 
stock  for  cash  to  sundry  persons 

Solution  No.  2,  may  be  termed  the  formal  method  of  opening  a 
set  of  corporate  books,  and  can  be  used  to  advantage  in  every 
case  in  that  thereunder  the  entire  authorized  stock  issue  always 
is  placed  upon  the  books  where  its  amount  is  under  scrutiny 
whenever  occasion  arises.  The  formal  method  follows  the  re- 
quirements of  both  the  Interstate  Commerce  Commission,  and 
the  Public  Service  Commission  of  New  York. 

Solution  No.  3.— The  formal  heading  is  omitted.  The  entries  ai-e  as 
follows: 


30,000.00 


30,000.00 


Date 

Unsubscribed  Capital  Stock— Common, 
Subscribed  Capital  Stock— Common, 
To— Authorized  Capital  Stock— Common, 

Date 
Unsubscribed  Capital  Stock— Preferred, 
To— Authorized  Capital  Stock— Preferred, 


$30,000.00 
20,000.00 


$50,000.00 


50,000.00 


50,000.00 


124 


ADVANCED  ACCOUNTING 


Date 


30,000.00 


30,000.00 


50,000.00 


20,000.00 
30,000.00 


Subscribed  Capital  Stock— Preferred, 

To— Unsubscribed  Capital  Stock— Preferred, 

Date 
Cash, 

To — Subscribed  Capital  Stock— Common, 
Subscribed  Capital  Stock— Preferred, 

It  is  desirable,  next,  to  notice  the  provisions  of  the  New.  York 
law  as  regards  the  issue  of  only  part  of  the  authorized  capital 
stock  of  a  corporation.  The  same  provisions  are  found,  in 
more  or  less  modified  form,  in  nearly  all  the  states.  The  'law 
provides  (B.  C.  L. ;  Art.  2)  : 

One-half  of  the  capital  stock  of  every  such  corporation  shall  be  paid 
in  within  one  year  from  its. incorporation,  or  the  corporation  shall  be 
dissolved,  and  the  directors,  within  thirty  days  after  such  payment 
shall  make  a  certificate  of  the  fact  of  such  payment,  which  shall  b^ 
signed  and  acknowledged  by  a  majority  of  the  directors,  and  verified 
by  the  president  or  vice  president  and  secretary  or  treasurer,  and  filed 
m  the  omces  where  the  certificates  of  incorporation  are  filed.  The  dis- 
solution of  any  such  corporation  for  any  cause  shall  not  take  away  or 
impau-  any  remedy  against  it,  its  stockholders  or  officers,  for  any 
liabihties  mcurred  previous  to  its  dissolution. 

Some  accountants  insist  that  no  record  need  be  made  in  the 
regular  books  of  account  of  the  capital  stock  authorized  but  un- 
subscribed and  unissued,  on  the  ground  that  the  certificate  of 
incorporation,  the  Stock  Ledger,  and  other  special  corporate 
records  are  sources  all-sufficient  from  which  to  determine  the 
authorized  issue.  Other  accountants  advocate  that  the  entire 
authorized  issue  shall  be  booked.  The  law  is  silent  upon  this 
point;  m  England,  a  corporate  Balance  Sheet,  when  published 
must  disclose  the  authorized  issue.  ' 

Although  either  method  may  be  used,  the  writer  ventures 
the  opinion  that  the  booking  of  the  entire  authoriaed  issue  in 
the  first  instance,  is  to  be  preferred  at  all  times.  Since  the 
published  corporate  Balance  Sheet  should  disclose  the  authorized 
issue,  as  this  may  have  a  marked  importance  upon  the  fact  that 
an  investor  may  or  may  not  purchase  such  stock,  the  General 
Ledger  should  have  the  authorized  amount  carried  thereon  in 


CORPORATIONSr-OPENING  ENTRIES 


125 


some  properly  ear-marked  account.  Again,  if  the  authorized 
amount  be  found  upon  the  Ledger,  considerable  time  may  be 
saved  at  some  future  day  by  a  strange  accountant  who  has 
been  called  in  to  do  certain  work,  and  who,  in  carrying  such 
work  through  to  a  satisfactory  conclusion,  finds  it  necessary  to 
determine  the  authorized  stock  issue.  This  second  point  may 
not  appear,  to  the  average  reader,  worthy  of  the  importance 
assigned  to  it;  however,  experience  is  a  good  teacher,  and  ex- 
perience has  demonstrated,  at  least  to  the  writer,  the  truth  of 
the  statement  made,  even  though  he  cannot  claim  to  be  the 
originator  of  it. 

Stock  Issued  for  Money  Only:  Fully  Subscribed — 
Issuance  on  Instalment  Plan. — Capital  may  be  paid  for  upon 
the  instalment  plan,  a  certain  amount  of  cash  to  be  paid  down 
at  once,  and  the  remainder  to  be  paid  in,  say,  at  equal  intervals 
in  specified  amounts.  Capital  stock  certificates  may  be  issued 
by  a  corporation  before  the  entire  subscription  has  been  paid. 
But  each  such  certificate,  upon  its  face,  must  show  that  the 
stock  is  not  fully  paid.  The  unpaid  amount  is  subject  to  call, 
as  agreed  upon.  After  full  payment  has  been  made,  fully  paid 
stock  certificates  will  be  issued. 

In  connection  with  this  subject,  there  is  a  provision  in  the 
New  York  law  which  reads  about  as  follows,  (S.  C.  L. ;  Art.  4) : 

The  original  or  the  aniended  certificate  of  incorporation  of  any  stock 
corporation  may  maintain  a  provision  expressly  authorizing  the  issue  of 
the  whole  or  of  any  part  of  the  capital  stocks  as  partly  paid  stock,  sub- 
ject to  calls  thereon  until  the  whole  thereof  shall  have  been  paid  in. 
In  such  cases,  if  in  or  upon  the  certificate  issued  to  represent  such 
stock,  the  amount  paid  thereon  shall  be  specified,  the  holder  thereof 
shall  not  be  subject  to  any  liability  except  for  the  payment  to  the 
corporation  of  the  amount  remaining  unpaid  upon  such  stock,  and  for 
the  payment  of  indebtedness  to  employees  pursuant  to  sections  .  .  .  .  ; 
and  in  any  such  case,  the  corporation  may  declare  and  may  pay  divi- 
dends upon  the  basis  of  the  amount  actually  paid  upon  the  respective 
shares  of  stock  instead  of  upon  the  par  value  thereof. 

Problem.— Assume  a  corporation  with  an  authorized  capital  stock  of 
$100,000.00.  The  issue  has  been  fully  subscribed  for,  50%  to  be  paid  in 
at  once,  and  the  remaining  50%  to  be  paid  for  at  equal  intervals  in  the 
amounts  of  20,  20,  and  10%.  The  cash  payments  to  be  made  at  stated  inter- 
vals have  been  provided  for  in  order  to  make  it  somewhat  easier  than 
otherwise  for  a  person  to  subscribe  to  the  stock. 


126 


I 


I 


ADVANCED  ACCOUNTING 


Solution  No.  1  -Three  methods  are  presented  for  solving  this  simple 
problem  m  order  to  show  that  no  one  fixed  rule  governs: 


Subscriptions, 

To— Capital  Stock, 


Dat« 


$100,000.00 


To  record  authorized  issue  and  subscrip- 
tions made  thereto 


$100,000.00 


Cash, 

To — Subscriptions, 

To  record  receipt  of  cash 


Date 


50,000.00 


50,000.00 


Date 


As  each  subsequent  payment  is  made,  entry  ' 

(2)  above,  would  be  repeated  covering  the 
amount  involved 


Date 
Subscriptions, 
Instalment  No.  1, 
Instalment  No.  2, 
Instalment  No.  3, 
To — Capital  Stock, 

To  record  authorized  issue  and  subscrip- 
tions made  thereto. 


$50,000.00 
20,000.00 
20,000.00 
10,000.00 


$100,000.00 


Cash, 

To — Subscriptions, 


Date 


$50,000.00 


To  record  cash  received  as  initial  payment 
for  stock. 


$50,000.00 


Cash, 
To — Instalment  No.  1, 


Date 


$20,000.00 


To  record  cash  received  in  payment  due  to 
first  call. 

Date 
Same  as  last  entry  made  above,  only  for  in- 
stalments Nos.  2  and  3,  as  each  one  is 
paid. 


$20,000.00 


CORPORATION&— OPENING  ENTRIES 


127 


Solution  No.  3. — This  solution  will  be  described  but  not  illustrated. 
A  separate  Ledger  account  is  carried  with  each  subscriber.  If  the  latter 
are  numerous,  a  special  Subscription  Ledger  may  be  used,  controlled  by  an 
account  upon  the  General  Ledger.  Under  this  condition,  the  Cash  Book 
must  contain  a  special  column  in  which  to  record  the  cash  amounts  re- 
ceived upon  subscription,  so  that  the  total  thereof  may  be  calculated 
readily  for  purposes  of  entry  in  the  controlling  account  upon  the  General 
Ledger.  It  may  be  that  the  volume  of  transactions  will  make  the  use  of  a 
special  Cash  Receipts  Register  desirable. 

Stock  Issued  for  Both  Money  and  Notes:  Partly  Sub- 
scribed. 

Problem. — ^Assume  a  company  incorporated  for  $100,000.00,  of  which 
$50,000.00  has  been  subscribed,  and  of  which  amount  one-half  has  been 
paid  in  cash  and  one-half  in  notes. 

Solution. — Only  one  method  of  recording  "the  above  is  shown.  Omitting 
the  opening  statement,  the  entries  to  cover  might  be  as  follows: 

Date 

Subscriptions,  $50 ,  000 .  00 

Unsubscribed  Stock,  50 ,  000 .  00 

To— Capital  Stock,  $100 ,000 .  00 
To  record  authorized  issue,  and  subscripn 
tions  made  there  against. 


Date 


$25,000.00 
25,000.00 


$50,000.00 


Cash, 

Notes  Receivable, 
To — Subscriptions, 

To  record  receipt  of  cash  and  notes  for  sub- 
scriptions paid,  one-half  each. 

It  should  be  remembered  that  under  the  statutes  which  re- 
quire stock  payments  to  be  made  in  cash,  labor  or  services,  or 
property,  the  receipt  of  notes  receivable  does  not  comply  with 
the  law.  Therefore,  whenever  a  note  is  found  to  have  been  given 
in  payment,  such  note  should  be  replaced  by  cash  immediately. 
(N.  Y.  Penal  Law:  sec.  644;  [3].) 

Organization  Expense. — Certain  expenses  are  absolutely 
necessary  as  being  incidental  to  the  incorporation  of  a  com- 
pany. Legal  services  are  necessary  in  connection  with  the  ap- 
plication for  a  charter,  and  with  the  advertising  in  the  local 
papers  of  the  fact  that  application  has  been  made  for  a  charter; 
stock  certificates  and  miscellaneous  supplies  must  be  purchased ; 
and  certain  filing  fees  must  be  paid. 

In  New  York,  the  filing  fee  amounts  to  one-twentieth  of  one 


I 


128 


ADVANCED  ACCOUNTING 


per  cent,  of  the  amount  of  the  authorized  capital  stock.  Like- 
wise, under  the  federal  law,  each  certificate  of  stock  issued  is 
taxed,  a  tax  stamp  or  stamps  being  required  to  be  affixed  to 
the  stubs  of  the  stock  certificates  issued. 

All  of  the  costs  of  the  above  indicated  nature  are  titled 
^'organization  expense."  Such  expense  is  in  the  nature  of  a  de- 
ferred charge  to  profit  and  loss  which  may  be  carried  upon  the 
books  as  an  asset  for  an  indefinite  length  of  time,  if  desired. 
However,  good  accounting  practice  advocates  writing  off  such 
expense  during  the  first  year,  or,  at  least,  within  the  first  three 
years  of  the  company's  existence.  Again,  if  the  amount  be 
sufficiently  large,  it  may  be  advisable  to  extend  the  period  to 
five  years. 

Capital  Stock  Premium  and  Discount.— Stock  selling  above 
par  IS  said  to  sell  at  a  premium.  Such  premium  should  be 
credited  to  an  account  properly  captioned,  as  Premium  on  Cap- 
ital Stock,  in  order  that  the  capital  stock  may  be  booked  at  par 
m  the  account  or  accounts  with  Capital  Stock.  When  stock 
IS  issued  at  a  premium,  the  disposition  of  the  premium  upon 
the  books  depends  upon  circumstances;  the  following  are 
illustrative  of  possibilities: 

1.  Interstate  Commerce  Commission  requirements.  Their 
amount  should  be  held  in  a  properly  ear-marked  account 
^  the  end  that  it  may  appear  always  upon  the  Balance 
Sheet  as  a  capital  stock  liability  until  extinguished  either 
by  discounts  suffered  on  subsequent  stock  sales  or  by  re- 
tiring stock.  As  stock  is  retired,  the  amount  of  premium 
applicable  thereto  should  be  charged  to  the  account  with 
such  premium  so  that  such  account  may  be  reduced  by  the 
amount  thereof. 

2.  When  organization  expenses  are  abnormally  large.  The 
organization  expenses  may  be  charged  against  the  premium 
account  as  above  titled,  or  against  the  premium  amount 
which  originally  was  credited  to  a  Special  Surplus  account 
Ihe  final  balance  in  the  latter  account  sometimes  is  trans- 
ferred to  regular  Surplus. 

3.  Permanent  surplus.  It  may  be  that  the  charter  or  by-laws 
provide  that  premiums  shall  not  be  available  for  dividends 
If  so,  the  credit  may  be  made  to  an  account  called  Perma- 
nent Surplus. 


CORPORATIONS-OPENING  ENTRIES 


129 


4.  Premium  amortization.     The  above  methods  all  consider 
capital  stock  premiums  as  neither  income  nor  profits,  which 
is  believed  to  be  correct.    Some  accountants,  however,  ad- 
vocate spreading,  or  amortizing,  the  premium  over  a  period 
of  years  by  crediting  the  Profit  and  Loss  account  with  a 
proportionate  amount  of  the  premium  each  month  or  year. 
These  accountants  consider  the  premium  as  a  profit  but  not 
an  operating  profit. 
The  opinion  is  ventured  that,  in  general,  capital  stock  premium 
should  be  considered  a  capital  surplus,  a  surplus  not  available 
for  dividends  even  though  the  law  does  not  restrict  the  premium 
being  distributable  as  dividends.    This  Capital  Surplus  account 
should  be  kept  open  and  never  transferred  to  regular  surplus. 
In  other  words,  the  first  method  above  is  preferred. 

Only  in  certain  states  may  capital  stock  be  sold  at  a  dis- 
count,— for  less  than  par.  And  even  where  such  practice  is 
permitted,  a  tendency  seems  to  exist  to  hide  the  true  facts  from 
being  shown  upon  the  books.  The  handling  of  this  discount  item 
upon  the  books  varies  considerably.  The  following  are  illustra- 
tive possibilities: 

1.  When  the  original  stock  is  sold  and  the  cash  received  is 
invested  in  a  capital  asset.  Under  this  condition,  the  dis- 
count may  be  charged  to  the  cost  of  the  asset,  in  view  of 
the  fact  that  an  item  called  ''Discount  on  Stock"  may  not 
be  desirable  upon  the  Balance  Sheet.  Naturally,  this  hand- 
ling of  the  situation  is  in  error  inasmuch  as  thereunder  the 
asset  value  has  not  been  recorded  correctly;  the  Balance 
Sheet  does  not  represent  facts  as  they  are  actually. 

2.  When  considered  as  an  organization  expense.  In  order  to 
eliminate  making  the  error  mentioned  above  in  (1),  and 
yet  keep  the  discount  item  off  the  Balance  Sheet,  as  such, 
the  charge  may  be  made  to  the  Organization  Expense  ac- 
count, on  the  ground  that  this  is  what  it  amounts  to,  to  be 
written  off  against  profit  and  loss  within  a  limited  number 
of  years.  However,  for  reasons  already  advanced  above, 
even  though  the  item  may  be  assumed  as  partaking  of  the 
nature  of  organization  expense,  it  is  of  sufficient  importance 
and  interest  to  require  a  separate  booking,  at  least. 

3.  When  considered  as  a  commission  to  be  given  the  purchaser 
of  the  stock.    This  method  is  not  apt  to  be  found  except 


H 


130 


ADVANCED  ACCOUNTING 


CORPORATIONS— OPENING  ENTRIES 


131 


in  states  which  prohibit  issuing  stock  at  a  discount.  The 
purchaser  of  the  stock,  or  a  dummy  broker  supposedly  rep- 
resenting the  purchaser,  buys  the  stock  at  par  and  receives 
m  return  the  amount  of  the  discount  as  a  commission.  In 
order  to  hide  this  commission  from  appearing  upon  the 
periodical  statement,  it  may  be  charged  to  a  capital  asset 
account.  Naturally,  this  whole  method  of  handling  has 
nothing  in  its  favor. 

4.  Interstate  Commerce  Commission  requirement.  Consider 
the  discount  as  a  permanent  item  thus  to  be  booked.  The 
item  is  carried  permanently  upon  the  books  under  its  true 
title,  being  reduced  from  time  to  time  by: 

a.  Premiums  secured  on  subsequent  stock  sales. 

b.  Assessments  levied  against  the  stockholders. 

c.  Appropriations  of  income  or  regular  (free)  surplus. 

d.  Retiring  stock;  here  the  proper  adjustment  must  be 
made  by  crediting  the  account  with  an  amount  equal  to 
the  unextinguished  discount  on  such  stock. 

In  accord  with  the  principles  of  the  fourth  possibility,  the 
Balance  Sheet  set-out  would  vary  with  the  ideas  of  the  par- 
ticular accountant: 

1.  Some  would  show  the  discount  as  a  deferred  asset 

2.  Others  would  show  the  discount  as  a  deduction  from  the 
par  value  of  the  capital  stock  outstanding.  The  writer 
favors  this  fourth  method  of  handling,  plus  the  second 
manner  of  showing  the  discount  upon  the  Balance  Sheet 

Treasury  Stock:   Definition  and   Status.-This  stock  has 
been  once  legally  issued  for  full  value  but  which  once  more  has 
come  mto  the  possession  of  the  issuing  company  either  by  pur- 
chase or  gift,  and  is  held  subject  to  disposal  by  the  directors 
Unissued  stock  never  should  be  confused  with  treasury  stock 
the  two  being  radically  dissimilar.    In  theory,  at  least,  treasury' 
stock  IS  worth  Its  face  value  and  may  be  carried  upon  the  books 
as  an  asset.    On  the  other  hand,  unissued  stock  or  unsubscribed 
stock  has  no  asset  value,  since  nothing  has  been  paid  for  it 
unless  the  subscriber's  obligation  to  pay  for  his  stock  is  looked 
upon  as  an  asset;  but  even  under  this  latter  contention,  the 
asset  is  the  claim  against  the  subscriber,  not  the  unissued  stock 
itself. 


Usually,  treasury  stock  is  held  in  the  corporate  name,  although 
at  times  it  is  assigned  to  the  treasurer  or  to  a  trustee.  When  held 
in  the  corporate  name,  the  received  stock  certificates  are  can- 
celled, and  proper  entries  made  upon  the  corporate  records  to 
show  that  such  stock  has  been  transferred  to  the  company. 
New  stock  certificates  would  not  be  issued  until  a  sale  has  been 
consummated  for  a  portion  thereof.  Treasury  stock,  upon  proper 
authorization  of  the  stockholders,  may  be  cancelled;  if  so,  it  is 
no  longer  treasury  stock,  since  its  status  reverts  to  that  of 
unissued  stock. 

Treasury  stock,  held  either  by  a  company,  or  by  a  trustee  for 
the  company,  is  inactive.  Being  so,  the  corporation  neither  can 
vote  its  treasury  stock  nor  draw  dividends  thereon.  (3  San- 
ford  Ch.  (N.  Y.)  285;  Morawetz  on  Corporations,  sec.  478); 
the  reasons  for  this  may  be  summarized  about  as  follows: 

1.  As  to  voting.  Treasury  stock  belongs  to  the  whole  body  of 
stockholders,  not  to  any  one  particular  stockholder  or  even 
to  the  majority  who  are  active. 

2.  As  to  dividends.  Dividends  are  paid  out  of  profits.  Profits, 
usually,  before  dividends  are  paid,  are  transferred  to  Sur- 
plus account.  And  if  a  dividend  is  paid  on  treasury  stock 
out  of  profits,  its  amount  would  be  returned  at  once  to  the 
Surplus  account  as  a  credit  out  of  which  it  just  was  paid. 

Accounting  Treatment  of  Treasury  Stock:  Donated 
Stock. — Basically,  it  would  seem  that  the  accounting  treatment 
involves  a  two-way  differentiation  so  far  as  the  books  of  accoimt 
are  concerned: 

1.  A  concern  secures  some  of  its  stock  through  a  donation. 

2.  A  concern  secures  some  of  its  stock  through  a  purchase. 
Each  point  seems  to  demand  a  discussion  of  some  length; 
hence,  a  separate  section  is  devoted  to  each  one. 

In  case  a  concern  secures  some  of  its  stock  through  a  dona- 
tion, it  is  possible,  again,  to  separate  the  discussion  into  two 
portions,  as  follows: 

1.  In  the  case  of  a  new  company  where  the  entire  capitaliza- 
tion has  been  issued  as  payment  for  some  property  which 
requires  either  complete  or  partial  development  so  as  to  be 
placed  upon  a  proper  operating  basis.  This  condition, 
usually,  arises  about  as  follows:  Some  one  in  interest,  who 
desires  to  maintain  a  controlling  interest  in  a  prospective 


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CORPORATIONS-OPENING  ENTRIES 


133 


corporation  wishes,  also,  to  provide  the  company  with  a 
supposedly  ready  means  of  securing  working  capital.  He 
may  own  some  land,  a  mine,  a  patent,  or  something  else 
which  well  could  be  used  by  the  enterprise  even  if  the 
latter  were  not  formed  specifically  to  develop  the  property 
(as  a  mine).  This  asset  is  sold  to  the  company,  usually, 
for  all  its  common  stock  issue  (except  two  or  three  shares 
required  by  law  to  be  held  by  others  so  that  the  corpora- 
tion may  be  formed  legally).  Naturally,  there  being  no 
cash  on  hand  for  development  purposes,  this  person  will 
donate  back  a  portion  of  his  received  holdings  (usually 
about  one-half)  to  be  disposed  of  at  whatever  price  they 
may  bring  or,  if  necessary,  to  be  given  away  in  part  as  a 
bonus  to  aid  the  sale  of  the  preferred  stock  (the  treasury 
stock  being  the  common  stock  and  two  classes  of  stock 
being  issued).    In  fact,  treasury  stock  may  be: 

a.  Sold,  usually  at  a  discount;  sometimes  at  a  premium. 

b.  Given  as  a  bonus  to: 

i.  Purchasers  of  other  classes  of  stock, 
ii.  Purchasers  of  bonds, 
iii.  Syndicates  underwriting  bond  issues. 
The    fund   of   proceeds    provided   through    the    sale    of 
treasury  stock  is  designated  best,  perhaps,   as   "working 
capital."     Therefore,  the  booking  of  treasury  stock,  when 
received,  might  be  as  under: 

Treasury  Stock  (at  par),  |  ^ 

To — Donated   Working   Capital    (or  Treasury 

Stock  Donation),  |  d 

In  certain  states  where  it  is  doubtful  whether  or  not  the 
legal  right  exists  for  a  corporation  to  hold  treasury  stock, 
the  donated  stock  could  be  placed  in  the  name  of  a  trustee, 
to  hold  same  subject  to  the  order  of  the  directors.  Later, 
when  the  treasury  stock  is  sold,  the  question  arises  as  to 
how  the  matter  should  be  dealt  with.  In  any  case,  the 
Treasury  Stock  account  should  be  credited  at  par.  The 
premium  or  discount  involved  will  be  handled,  in  general, 
according  to  circumstances;  but  even  here  it  would  seem 
that  only  one  principle  is  involved:  The  premium  secured, 
or  the  discount  lost,  eventually,  must  be  either  a  credit  or 


a  charge  against  the  working  capital,  as  the  case  may  be. 
The  difference  in  handling  may  be  indicated  about  as 
follows : 

a.  If  all  the  stock  is  sold  by  one  sale.  Credit  the  amount  of 
the  premium,  or  charge  the  amount  of  the  discount,  at 
once  against  the  account  of  Donated  Working  Capital. 

b.  If  the  stock  is  sold  piecemeal.  Since  most  of  the  stock, 
as  a  rule,  will  be  sold  at  a  discount  rather  than  at  a 
premium,  it  is  perhaps  safe  to  say  that  the  only  account 
needed  will  be  the  Stock  Discount  account,  which  should 
be  charged  or  credited,  as  the  case  may  be,  for  the  dis- 
count or  premium,  in  order  to  secure  a  basis  for  verify- 
ing each  period's  sales  in  connection  with  the  period's 
rate  or  price  as  set  by  the  directors.  In  the  interim, 
before  all  the  stock  is  sold,  the  amount  of  the  stock  dis- 
count would  be  shown  upon  the  Balance  Sheet  deducted 
from  the  Working  Capital  account,  and  the  net  balance 
represents  two  things: 

i.  Amount  of  treasury  stock  still  on  hand, 
ii.  Amount  of  cash  actually  received  from  sales  made. 
After  all  the  treasury  stock  has  been  sold,  the  net  balance 
in  the  Working  Capital  account  represents  the  amount  of 
cash  actually  realized  from  sales  made.  The  final  point 
hereunder  relates  to  the  disposition  to  be  made  of  this 
Working  Capital  account  balance.  Briefly,  the  principle 
suggested  may  be  indicated  as  under: 

a.  Close  out  the  balance  to  free  Sm-plus  account,  where  it 
would  be  available  for  dividends.  But  if  dividends  be 
declared  therefrom,  it  stands  to  reason  that  the  pur- 
pose of  the  gift  has  been  defeated  unless,  perhaps,  the 
dividends  so  distributed  are  stock  dividends.  However, 
it  appears  that  no  legal  restriction  exists  against  treat- 
ing such  an  item  as  free  surplus. 

b.  Close  out  the  balance  to  a  special  Surplus  account,  as 
Capital  Surplus  account  in  which,  presumably,  such  bal- 
ance will  not  be  available  for  dividends.  However,  when 
an  account  carries  the  word  "surplus"  in  its  caption,  a 
strong  temptation  exists  to  make  use  of  a  mere  book 
entry  and  thereby  transfer  such  balance  to  the  free  Sur- 


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plus  account.  And  when  once  therein,  dividends  may 
be  declared  therefrom,  as  before,  resulting  in  the  defeat 
of  the  purpose  of  the  gift.  Such  manipulation  often  re- 
sults where  one  or  more  periods  have  suffered  extraordi- 
nary losses  resulting  in  the  earned  profits  not  being  suffi- 
cient for  the  dividends  contemplated. 
c.  Close  the  balance  out  to  the  credit  of  the  asset  account 
representing  the  asset  which  gave  rise  to  the  treasury 
stock.  Again,  whether  or  not  this  practice  is  in  order, 
would  seem  to  depend  upon  circumstances: 

i.  In  the  case  of  a  mining  company.    Since  the  stock 
was  donated  to  pay  for  the  cost  of  developing  the 
property,    it   would   seem   that   the   development 
cost,  as  totaled  in  a  Development  Expense  account, 
{considered  during  the  interim  as  an  asset),  could 
be  charged  against  the  Working  Capital  account, 
which,  in  turn,  could  be  credited  out  against  the 
Mine  account, 
ii.  In  the  case  of  an  ordinary  company.     Here  it  is 
assumed  that  the  asset  acquired  should  not  be 
valued  at  the  par  value  of  the  capital  stock  issued 
therefor.    The  effect  of  such  treatment  would  be 
to  reduce  the  book  value  of  the  asset.    However, 
such  treatment,  theoretically,  at  least,  seems  in- 
consistent in  that,  in  the  original  instance,  the 
directors  fixed  the  value  of  this  asset,  and  such 
prescribed  value  would  now  be,  apparently,  in  seri- 
ous error  to  the  end  that,  by  this  means  of  clos- 
ing, the  directors  may  expose  themselves  to  the 
odium  of  appearing  guilty  of  fradulent  practices 
In  New  York,  (S.  C.  L.;  Art.  4) :    "In  the  absence 
of  fraud  in  the  transaction  the  judgment  of  the 
directors  as  to  the  value  of  the  property  purchased 
shall  be  conclusive." 
d.  Since  by  reason  of  the  gift,   future   stockholders   are 
benefited  as  well  as  the  present  ones,  the  Working  Capi- 
tal or  Treasury  Stock  Donation  account  is  carried  along 
permanently  upon  the  books  in  the  same  manner  as  the 
account     holding     unextinguished     premiums     secured 
through  the  sale  of  stock. 


CORPORATIONS-OPENING  ENTRIES  135 

e.  Where  a  company  has  a  considerable  amount  of  organi- 
zation  expense,    some    accountants    advocate   reducing 
such  amount  by  the  amount  of  treasury  stock  donated 
rather  than  make  a  credit  to  some  other  account. 
^     2.  In  the  case  of  a  company  which  has  been  going  some  time 
fetock  IS  donated  to  the  treasury  of  such  a  concern,  either 
to  wash  a  deficit  or  to  be  sold  to  provide  additional  ready 
workmg  capital.    Here,  briefly,  the  treatment  is  illustrated 
as: 

a.  If  desired  to  be  available  for  dividends,  credit  Surplus 
account. 

b.  If  the  gift  be  made  under  the  condition  that  it  must 
remain  as  permanent  working  capital,  credit  a  special 
burplus  account,  to  show  it  is  not  available  for  dividends. 

c.'^l^'Tri"^  Treatment  of  Treasury  Stock:  Purchased 
!u  :  „?  ^  ''°°''^™  purchases  some  of  its  own  stock,  say, 
either  to  sell  later  at  a  price  in  excess  of  that  originally  obtained 
for  It,  or  to  avoid  the  payment  of  large  dividends  earned  and 
about  to  be  declared,  or  for  some  other  reason,  the  question  of 
book  treatment  arises  again: 

1.  At  what  value  shall  the  booking  be  made?  The  stock 
should  be  placed  in  the  treasury  at  par.  This  investment 
IS  not  similar  to  an  investment  made  in  an  outside  concern 
since,  at  least  for  the  time  being,  treasury  stock  amounts 
to  a  reduction  in  the  company's  capital  stock,  to  be  carried 
upon  the  Balance  Sheet  as  a  deduction  from  the  total  stock. 
This  deduction  cannot  be  made  if  the  offsetting  items  are 
of  unlike  components. 

2.  When  purchased  at  a  premium.     The  vendor,  in  this  in- 
stance, has  sold  two  things  or  elements  to  the  company 

a.  A  certain  number  of  shares. 

b.  A  portion  of  his  undivided  interest  in  the  company's  sur- 

Therefore,  it  would  seem  that  the  premium  involved 
should  be  charged  against  Surplus  account;  if  so  the 
remammg  shares  outstanding  would  have  a  book  Calue 
represented  by  the  par  of  the  stock  outstanding  plus  the 
remaining  surplus. 

3.  When  purchased  at  a  discount.    The  purchase  at  a  discount 


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ADVANCED  ACCOUNTING 


is  not  the  exact  reverse  of  a  purchase  at  a  premium;  the 
premium  represents  an  actual  cash  loss  offset  by  a  reduc- 
tion in  surplus;  whereas,  the  discount,  at  best,  is  only  a 
paper  profit.  The  discount,  therefore,  should  be  credited  to 
a  properly  ear-marked  account  indicating  a  contingent 
profit.  When  the  stock  is  sold,  this  account  would  be  ad-' 
justed  in  the  amount  of  the  premium  or  discount  involved, 
after  which,  the  remaining  balance  in  the  contingent  profit 
(or  loss)  account  represents  the  actual  realized  profit  or 
loss  resultant. 

Opposed  to  the  above  method  of  handling,  as  in  (2)  and  (3), 
above,  consider  the  following: 

1.  The  excess  paid  above  par  or  the  difference  between  par  and 
the  amount  paid  (where  the  latter  is  less  than  par)  is  debited 
or  credited  to  Profit  and  Loss  account.  The  assumption 
here  is  that  an  additional  loss  or  profit  has  resulted  for  the 
period  in  which  the  stock  was  bought. 

2.  A  debit  or  credit  is  made  to  a  special  account  of  Premiums 
and  Discounts  on  Treasury  Stock.  The  assumption  here  is 
that  an  additional  loss  or  profit  has  been  incurred  which  is 
applicable  proportionately  to  a  number  of  subsequent 
periods,  to  the  end  that  such  account  gradually  is  washed 
by  periodical  amortization. 

3.  Carry  permanently  the  premiums  as  liabilities  and  the  dis- 
counts as  assets  until  offset  by  subsequent  activities. 

Although  the  writer  favors  the  first  indicated  methods  above 
shown,  it  would  seem  that  of  the  second  group,  the  third  possi- 
bility has  more  to  be  said  in  its  favor  than  the  other  two  shown 
as  alternatives,  because  of  the  usual  reasons  advanced  therefor, 
which  may  be  stated  about  as  follows:  Such  purchase  activity 
has  no  relation  whatever  to  income,  and  the  assumed  gains  due 
to  discounts  should  belong  exclusively  to  the  business,  whereas 
assumed  losses  should  not  be  charged  against  the  current  stock- 
holders to  the  end  that,  by  so  doing,  future  stockholders  may 
secure  an  advantage  over  the  present  ones  to  which  they  are  not 
entitled. 

In  conclusion,  it  might  be  said  that  the  choice  of  the  method  to 
be  used  relative  to  handling  treasury  stock  is  a  matter  more  or 
less  to  be  decided  upon  by  the  directors. 


!■■'  'i 


CHAPTER  V 

CORPORATIONS:    ORGANIZATION;    RECORDS; 
OPENING  ENTRIES  (Continued) 

Genesis  of  a  Proposed  Corporation. — The  idea  of  organizing 
a  particular  corporation  originates  with  some  one  individual; 
even  the  organization  details  may  be  planned  by  him.  The  con- 
ceiver  of  the  idea  broaches  his  proposition  to  certain  friends  be- 
lieved to  be  best  fitted  and  most  likely  to  join,  and  aid,  him  in 
floating  the  enterprise.  After  the  feasibility  of  the  plan  has  been 
discussed  informally,  a  formal  meeting  is  called  to  shape  and 
define  the  various  angles  of  the  organization  scheme,  perhaps 
about  as  follows: 

1.  Purpose  of  the  corporate  endeavor. 

2.  Who  the  directors  shall  be  for  the  first  year. 

3.  What  shall  be  the  amount  and  kinds  of  capital  stock,  the 
number  of  shares  of  each  kind,  the  par  value  of  each,  and 
the  manner  of  payment  therefor. 

All  of  these  facts  must  be  set  out  in  the  certificate  of  incorpo- 
ration when  the  latter  is  framed.  Many  variations  from  the 
above  are  found,  but  for  illustrative  purposes  it  seems  unneces- 
sary to  consider  them  here. 

Filing  the  Certificate  of  Incorporation. — ^In  general,  the 
organization  procedure  is  the  same  in  all  states,  only  the  details 
presenting  variations.  Since  the  New  York  law  specifies  that 
the  incorporators  must  be  "natural  persons  of  full  age,"  minors, 
partnerships,  corporations,  and  persons  acting  in  a  representative 
capacity  are  considered  incompetent  to  organize  a  corporation. 

The  articles  of  incorporation  must  be  prepared  in  the  English 
language,  must  be  signed  by  each  incorporator,  and  must  be 
acknowledged  either  before  a  notary  public  or  other  ofl&cer  capa- 
ble of  taking  acknowledgments.  One  of  the  most  important 
portions  of  the  incorporation  laws  in  every  state  relates  to  the 
contents  of  these  articles.    To  conserve  space,  and  also  because 

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of  the  fact  that  a  competent  attorney  should  be  on  hand  when 
the  formation  of  a  corporation  is  contemplated,  the  major  points 
to  be  contained  therein  have  been  omitted  purposely.  (But  see 
N.  Y.,  B.  C.  L.,  Art.  2.) 

Frequently,  the  specific  parties  interested  in  organizing  a  cor- 
poration may  wish  to  hide  their  identity  until  after  the  company 
actually  has  come  into  existence.  If  so,  the  legal  expedient  of 
organizing  the  corporation  with  dummy  incorporators  who,  gen- 
erally, are  attorney's  clerks,  is  made  use  of.  The  least  number 
of  incorporators  allowed  by  law  are  permitted  to  subscribe  for 
the  smallest  number  of  shares  necessary  to  bring  the  corporation 
into  existence.  Similarly,  the  advertised  directors  for  the  first 
year  may  be  dummies;  at  the  first  meeting  of  the  board  of 
directors,  after  incorporation,  these  dummies  resign  and  the  regu- 
lar directors,  who  are  to  manage  the  company,  succeed  them. 

After  the  incorporation  certificate  has  been  prepared,  it  must  be 
filed  and  recorded  with  the  proper  authorities.  It  seems  to  be  a 
practical  idea  to  send  three  copies  of  this  certificate  to  the  office 
of  the  Secretary  of  State.  One  copy  is  retained  there  to  be  filed 
and  recorded;  the  remaining  two  are  certified  and  then  disposed 
of, — one  to  the  office  of  the  County  Clerk  to  be  filed  and  re- 
corded, and  the  other  to  the  office  of  the  corporation  for  its  files. 

Prior  to  filing  with  either  the  Secretary  of  State  or  the  County 
Clerk,  in  New  York,  the  organization  tax  must  be  paid  the  State 
Treasurer,  one-twentieth  of  one  per  cent.,  or  fifty  cents  for  each 
11,000.00  of  the  authorized  capital  stock.  The  State  Treasurer's 
ofiice  makes  a  duplicate  receipt  to  cover  this  payment,  one  copy 
to  be  sent  the  corporation  and  the  second  to  be  sent  the  Secretary 
of  State.  When  filing  the  articles  with  the  Secretary  of  State, 
the  requisite  fees  at  this  point  must  not  be  forgotten, — for  filing 
and  recording;  likewise,  there  is  a  fee  payable  to  the  County 
Clerk  for  filing  and  recording.  "No  corporation  shall  exercise 
any  corporate  powers  or  privileges  imtil  such  taxes  and  fees  have 
been  paid."     (G.  C.  L.,  Art.  2.) 

Since  the  corporation  is  not  in  existence  when  the  initial  fees 
must  be  paid,  this  item  is  taken  care  of  in  one  of  the  following 
ways: 

1.  The  incorporators  advance  the  money  to  their  attorney  who 
prepares  the  incorporation  papers  and  attends  to  incorpo- 


CORPORATIONS^ORGANIZATION ;  RECORDS 


139 


rating  the  company.    No  one  but  an  attorney  should  pre- 
pare these  papers. 

2.  The  incorporators  advance  the  money  to  one  of  their  num- 
ber who  is  charged  with  attending  to  such  payment. 

3.  The  incorporators  pay  a  portion  or  all  of  their  subscriptions 
in  advance,  so  that  the  attorney  or  one  of  themselves  may 
have  the  money  required. 

As  to  fees,  see: 

1.  Executive  Law  of  New  York,  section  26. 

2.  Code  of  Civil  Procedure  of  New  York,  section  3304. 

Amending  the  Certificate  of  Incorporation;  Reincorpora- 
tion.— The  articles  of  incorporation  of  an  incorporated  company 
may  be  amended,  in  general,  in  any  way  deemed  desirable  except 
that,  in  so  doing,  the  prescribed  powers  which,  at  the  time  of 
amendment,  apply  to  corporations  engaged  in  business  of  the 
same  general  character  or  which  might  have  been  included  in 
such  articles  but  were  not,  cannot  be  exceeded. 

Stockholders  representing  three-fifths  of  the  outstanding  shares 
of  each  class  of  stock  issued  must  authorize  such  amendment  at 
a  special  meeting  called  for  that  purpose,  notice  of  which  must 
be  given  according  to  law.  Likewise,  the  majority  of  the  direct- 
ors must  authorize  such  amendment.  (See  New  York  S.  C.  L.; 
Art.  2,  sec.  22.) 

The  Business  Corporations  Law,  Article  2,  section  4,  sets  out 
the  procedure  to  follow  in  case  an  existing  corporation  wishes 
to  reincorporate.  In  this  connection,  moneyed,  transportation, 
banking  and  insurance  corporations  are  excluded.  A  special 
meeting  of  the  stockholders  must  be  called  legally  by  the  directors 
for  this  purpose,  a  majority  of  the  latter  signing  such  call.  Votes 
representing  a  majority  of  all  the  stock  of  the  corporation  out- 
standing must  be  cast  in  favor  of  the  proposition.  In  no  way, 
by  such  procedure,  can  a  corporation  avoid  existing  liabilities. 

First  Regular  Meeting.— After  all  the  requirements  of  the 
law  have  been  met,  in  the  original  incorporation  of  a  company, 
the  corporation,  as  a  distinct  and  legal  entity,  comes  into  exist- 
ence. Immediately  thereafter,  the  first  regular  meeting  of  the 
stockholders  is  held.  In  some  states  the  corporation  comes  into 
existence  as  soon  as  the  State  has  accepted  the  articles  of  incor- 


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poration  (date  filed),  as  New  York,  and  in  other  states  the 
stockholders  first  must  have  their  first  regular  meeting  at  which 
the  articles  will  be  accepted.  If  the  organizers  of  a  corporation 
have  been  doing  business  before  all  requirements  have  been  com- 
plied with  and  have  incurred  certain  debts,  they  are  liable  for 
such  debts  as  partners. 

At  this  meeting,  also,  the  by-laws  are  adopted,  unless  the  stock- 
holders should  waive  their  rights  in  this  particular  and  delegate 
them  to  the  directors.  Since  the  stockholders,  legally,  are  not 
agents  of  the  corporation,  they  elect  a  board  of  directors  to 
manage  the  corporate  affairs.  In  turn,  this  board  functions  by 
appointing  officers  to  whom  it  delegates  certain  of  its  powers. 
And  in  order  to  circumscribe  and  keep  all  persons  within  due 
bounds,  by-laws  are  enacted.  Insofar  as  these  do  not  conflict 
with  the  laws  of  the  State  and  the  certificate  of  incorporation, 
these  by-laws  regulate  the  relations: 

1.  Of  stockholders  with  directors. 

2.  Of  directors  with  stockholders. 

3.  Of  directors  with  officers. 

4.  Of  the  corporation  with  outsiders  who  are  familiar  with 
the  by-laws  and,  therefore,  assumed  to  accept  their  validity. 
(Angel  and  Ames  on  Corporations,  sec.  325;  1  Gray  317; 
43  Me.  192;  7  Barb.  508;  9  Howard  (U.  S.)  172;  Potter, 
Law  of  Corporations,  vol.  1,  p.  116.) 

In  general,  after  the  board  of  directors  has  been  elected,  the 
stockholders  must  act  through  it  because,  unless  the  by-laws 
restrict,  this  board  practically  has  the  same  power  as  the  cor- 
poration. The  directors  really  occupy  the  role  of  being  trustees 
of  both  the  stockholders  and  the  corporate  creditors  (54  N.  Y. 
314).  Such  being  the  case,  they  may  not  take  unto  themselves 
any  advantage  which  cannot  be  shared  by  the  stockholders 
(Potter  on  Corporations,  vol.  1,  sec.  85;  168  N.  Y.  157;  146  U.  S. 
536),  or  which  would  reduce  creditors'  rights  to  a  position  subor* 
dinate  to  their  own  (42  Md.  598,  605).  Some  of  the  powers  and 
restrictions  accruing  to  directors  may  be  set  out  as  under: 

1.  Powers: 

a.  To  borrow  money   against   a  pledge  of  the   corporate 
assets;  the  by-laws,  however,  may  deny  this  right. 


CORPORA TION&-ORGANIZA TION ;  RECORDS 


141 


b.  To  lease  the  corporate  property  where  such  action  will 
not  deprive  the  company  of  the  power  to  conduct  its  own 
business. 

c.  To  incur  new  debts  in  order  to  pay  off  old  ones. 

d.  To  ratify  a  debt  barred  by  the  Statute  of  Limitations. 

e.  To  make  and  transfer  negotiable  paper. 

f.  To  carry  through  company  litigation  at  the  expense  of 

the  latter, 
g.  To  fix  official  salaries. 

h.  To  authorize  the  payment  of  wages  in  advance, 
i.  To  make  service  contracts  with  persons  having  services 

to  sell  or  to  hire, 
j.  To  pay  dividends  out  of  profits  earned,  as  they  may 

desire. 

2.  Restrictions: 

a.  To  usurp  the  powers  of  the  stockholders  under  the 
statute. 

i.  To  increase  or  decrease  the  capital  stock, 
ii.  To  dissolve  the  corporation, 
iii.  To  remove  a  director  from  office. 

b.  To  amend  the  by-laws. 

c.  To  cancel  stock  purchased  upon  the  open  market. 

d.  To  cancel  stock  subscriptions  (Spelling  on  Private  Cor- 
porations, vol.  2,  sec.  57). 

e.  To  issue  more  stock  than  the  authorized  amount  (105 
U.S.  143). 

f.  To  issue  stock  at  less  than  par,  unless  statutes  permit, 
g.  To  lease  corporate  property  to  the  end  that  the  company 

will  be  deprived  of  the  power  to  conduct  its  own  business 

(33  Barb.  578) . 
h.  To  vote  by  proxy, 
i.  To  declare  dividends  unlawfully. 

Immediately  after  the  stockholders  have  held  their  first  meet^ 
ing,  the  first  meeting  of  the  directors  is  held.  Here  the  by-laws 
as  submitted  are  approved  and  adopted, — unless  they  themselves 
have  been  authorized  to  frame  them, — ^the  issue  of  shares  of 
capital  stock  for  cash,  services,  or  for  property,  is  authorized,  the 
manner  of  signing  corporate  checks  is  determined  upon,  election 


II 

! 


142 


ADVANCED  ACCOUNTING 


inspectors  are  appointed  for  the  ensuing  year,  and  any  other 
miscellaneous  matters  which  come  within  their  province  as 
directors  are  decided. 

The  directors  hold  whatever  meetings  are  necessary,  regular 
and  special,  to  carry  out  their  policy  of  management.  They  must 
not  exceed  their  authority  because,  if  they  do  so,  a  personal 
habihty  may  attach.  They  must  act  as  a  body,  not  individually 
m  carrying  out  their  duties.  A  delegation  of  their  authority  is' 
not  possible  unless  such  delegation  involves  merely  the  perform- 
ance of  a  mmisterial  act;  acts  involving  discretion  are  not  to  be 
delegated.  The  directors  hold  office  until  their  successors  have 
been  elected. 

Continuity  of  management  may  be  insured  by  tying  ud  the 
stock  m  a  -voting  trust"  for  a  term  of  years.  The  New  York 
law  permits  such  a  formation  (G.  C.  L.;  art.  2i,  but  restricts  the 
period  for  which  such  a  trust  may  be  formed  to  a  length  not  to 
exceed  five  years.    In  most  states,  a  voting  trust  may  be  formed 
for  a    reasonable  period"  and  what  this  is  is  left  to  the  Courts 
to  determine.    A  voting  trust  refers  to  accumulating  shares  of 
stock  from  various  stockholders,  under  a  written  agreement,  into 
the  hands  of  one  or  more  persons  in  whom  thereby  is  vested  the 
right  to  vote  such  stock  in  accord  with  the  terms  set  out  in  the 
agreement.    In  New  York,  at  least,  the  transferred  stock  certifi- 
cates  must  be  cancelled  and  new  ones  issued  in  the  name  or  names 
of  the  persons  to  whom  the  transfer  is  made.    After  recording 
such  transfers  in  the  proper  corporate  books,  the  stock  may  be 
voted  during  the  continuance  of  the  agreement  by  the  transferee 
or  transferees.    Duplicate  copies  of  each  such  agreement  are  on 
ftle  in  the  principal  corporate  office  where  they  may  be  examined 
during  business  hours  by  the  stockholders. 

If  the  directors  are  guilty  of  an  illegal  act,--as  paying  part  of 
the  corporate  capital  to  stockholders,  etc.,-they  are  jointly  and 
severally  liable  to  the  corporation,  and  to  the  corporate  creditors 
for  any  damage  caused.  In  this  connection,  no  director  will  be' 
held  guilty  If  he  does  not  agree  to  such  illegal  act  and  has  had 
such  fact  recorded  in  the  minutes  of  the  meeting  at  which  such 
act  was  agreed  to  (Potter  on  Private  Corporations,  sec.  337)- 
likewise,  if  a  director  was  not  present  at  such  meeting  he  will 
not  be  held  guilty. 


CORPORATIONS-ORGANIZATION;  RECORDS  143 

Corporate  Officers.— The  number  of  officers  a  corporation 
has,  and  the  duties  falling  to  each  one,  depend  upon  the  particular 
corporation  under  discussion.  In  most  cases,  one  will  find  a 
president,  one  or  more  vice-presidents,  a  secretary  and  a 
treasurer : 

1.  President.  He  is  assumed  to  be  the  chief  official  of  the 
corporation.  If  the  board  of  directors  is  an  active  body 
his  duties  primarily  are  limited  in  scope,  presiding  over  the 
directors'  meetings  and  over  the  meetings  of  the  stock- 
holders. Where  the  board  of  directors  is  an  inactive  body 
his  duties  may  be  many  and  important  since  he  has  the 
power  of  a  general  agent  of  the  corporation.  He  plans  the 
policies  and  has  supreme  executive  control  over  all  the  other 
officials  and  over  the  company  employees.  However,  the 
exact  nature  of  his  power  depends  upon  both  the  nature  of 
the  company  and  upon  business  custom. 

2.  Vice-president.  He  takes  upon  himself  the  duties  of  the 
president  when  the  latter  is  not  where  he  can  act,  and  certain 
other  duties  of  a  regular  nature  depending  upon  the  case 
in  hand.  Where  there  are  a  number  of  vice-presidents,  they 
are  ranked  as  first,  second,  etc.,  and  each  has  certain  regular 
managerial  duties  falling  to  his  lot,  depending  upon  the 
corporate  by-laws. 

3.  Treasurer.  He  is  usually  the  financial  officer  of  the  com- 
pany, having  charge  of  the  cash  funds  and,  at  times  of 
certain  of  the  accounting  records.  Usually,  he  signs  'the 
checks,  and  selects  the  depositaries. 

4.  Secretary.  He  has  charge  of  recording  the  happenings  in 
the  stockholders'  and  directors'  meetings,  and  he  has  custody 
of  the  corporate  seal.  Other  duties  may  fall  upon  his 
shoulders,  dependent  upon  the  corporate  by-laws.  He  may 
be  assisted  in  his  work  by  one  or  more  assistant  secretaries 

5.  Comptroller  or  auditor.     This  official  usually  is  found  in 
large  corporations  rather  than  in  small  ones.     He  has  direct 
charge  of  all  matters  pertaining  to  the  accounting  activities 
Usually,  he  is  responsible  only  to  the  board  of  directors  not 
to  any  one  official.  ' 

Corporate  Records.-Corporation  accounting  is  based  upon 
the  general  principles  of  accounting,  and  the  financial  records 


144 


ADVANCED  ACCOINTING 


kept  practically  are  the  same  as  those  of  any  ordinary  business  — 
Journals,  Purchase  Records,  Sales  Records,  Cash  Books,  Ledgers 
etc.  Likewise,  the  general  scheme  of  the  accounts  in  a  corpora- 
tion may  be,  and  usually  is,  the  same  as  that  employed  in  a 
partnership,  or  even  as  that  used  by  a  sole  trader.  The  diffenmce 
between  corporate  accounting  practice  and  that  of  other  general 
forms  of  business  activity  is  found  in  the  opening  entries  the 
c  osmg  entries,  the  recording  of  the  proprietorship  interest/  and 
the  distribution  of  profits.  However,  because  of  the  peculiarities 
of  its  organization,  a  corporation  requires  certain  books  and 
records  which  are  not  needed  either  in  the  partnership  or  the 
sole  proprietorship  type  of  business.  These  records  have  but 
little  to  do  with  accounting  principles. 

By  law,  each  corporation  is  required  to  keep  books  in  which  a 
complete  record  of  all  its  business  and  transactions  are  entered 
These  books  must  be  kept  at  the  principal  office  of  the  corpora- 
tion (N.  Y.,  S.  C.  L.;  art.  2).  And  under  proper  regulations, 
these  records  may  be  examined  by  the  stockholders  as  a  common 
law  right  which,  at  least  in  the  State  of  New  York  cannot  be 
impaired  by  legislation  (159  N.  Y.  250;  70  N  Y  220)  If  a 
stockholder  is  refused  permission  to  make  an  examination  of 
these  records  under  the  regulations  set  down,  by  showing  proper 
cause  for  making  such  examination,  he  can  secure  a  Supreme 
Court  order  compelling  the  corporation  to  allow  him  to  make  such 
examination.     (159  N.  Y.  250;  12  Wend.  183.) 

Although  the  exact  requirements  in  regard  to  the  number  and 
form  of  corporate  books  vary  considerably  from  state  to  state 
the  general  scheme  covering  such  records  would  be  about  as 
below : 

1.  Minute  Book. 

2.  Subscription  List  or  Book. 

3.  Instalment  Book  or  Subscription  Ledger. 

4.  Instalment  Receipt  or  Scrip  Book. 

5.  Stock  Certificate  Book. 

6.  Stock  Ledger  or  Book. 

7.  Stock  Transfer  Journal. 

8.  Stock  Transfer  Book. 

9.  Bond  Register. 

The  stock  records  comprise  a  group  so  distinct  from  the  regular 


II 


CORPORATIONS^RGANIZATION ;  RECORDS  145 

financial  records  that  in  large  corporations  they  are  kept  by  a 
different  force  of  operatives  in  a  separate  room  or  department  in 
charge  of  a  special  officer  titled  Transfer  Agent  or  Transfer  Clerk 
Mmute  Book—This  record  should  contain  the  complete 
chronological  record  of  all  the  meetings  of  the  stockholders  and 
of  the  directors.  Usually,  it  is  kept  by  the  secretary.  The  story 
therein  contained  should  be  worded  in  the  clearest  manner  pos- 
sible  so  as  to  avoid  having  any  ambiguity  or  misunderstanding 
arise  at  a  later  date.  It  is  an  exceedingly  important  record 
because  in  reality,  it  is  the  written  history  of  the  acts  of  the 
corporation^    Its  contents,  when  properly  approved,  cannot  be 

tCx^led."  ""'  *^^""""^'  ^'*'^°"^^  ^"^•^  ^-*-*^  ->^  ^ 
The  Minute  Book  has  no  special  form;  it  may  be  either  bound 
or  loose-leaf.    The  minutes  may  be  written  therein  or  they  may 
Ai^r  wu   ',*  "^  '°°''  '•'''*'  ^h'^l^  afterwards  are  pasted  in 

i!t  TS  *t  T^'Y  ^'"■'°  ^'  *^^  "«'^*  convenient,  it  is  sug^ 
gested  that  the  bound  form  is  less  apt  to  be  altered  should  occa- 
sion arise  when  such  alteration  is  assumed  to  be  desirable.  In  one 
particular  instance,  two  years  after  certain   resolutions  were 

al'^l^P""  'S!  ™'°"*'';  '^^  '^"'''''''  fi^'^'-'K  them  undesir- 
able,   emoved  the  original  sheets  and  replaced  these  by  others 

oTtulfH  '7  different  way  in  an  attempt  to  reduce  the  amount 
ot  the  then  determined  income  and  excess  profits  tax 

The  minutes  of  the  first  stockholders'  meeting  would  cover  the 
following  major  points:  persons  present,  by-laws,  purchase  of 
property,  issue  of  stock,  recording  articles  of  incorporation,  stock 
assessments  nomination  and  election  of  directors,  etc  The 
minutes  of  the  first  meeting  of  the  board  of  directors  ;ould  cove^ 
the  following  prominent  points:  directors  present,  election  of 
oflicers,  minutes  of  incorporation,  oath  of  secretary,  bond  of 
treasurer,  issue  of  stock,  signing  of  checks,  subsequent  meetings 
committees,  approval  of  agents  and  agencies,  salaries  of  officers 
sale  of  securities,  powers  of  attorney,  etc. 

Subscription  List  or  Register;  Subscription  Ledger.-The 
use  of  these  two  records  begins  at  the  time  a  corporation  is 
organized.    Such  use  may  be  described  about  as  follows  • 

"  *'\t  ""T^^"  "^  subscribers  to  the  stock  of  a  corporation  is 
small.    When  the  Journal  entry  is  made  charging  "Sub- 


.1  ' 


146 


ADVANCED  ACCOUNTING 


scribers"  for  the  amount  of  the  subscribed  stock,  it  is  suffi- 
cient to  enter  the  name  and  subscription  of  each  subscriber 
upon  the  Journal,  and  open  an  account  with  each  one  upon 
the  General  Ledger.  A  formal  Subscription  List  is  unneces- 
sary although,  theoretically,  it  may  be  used.  In  brief,  such 
a  list  records  the  contract  existing  among  the  subscribers 
whereby  each  binds  himself  to  take  the  amount  of  stock 
set  down  next  to  his  signature. 
2.  If  the  number  of  subscribers  to  the  stock  of  a  corporation 
is  large.  In  this  case,  a  Subscription  List  may  be  used  as 
the  written  evidence  of  the  contract  between  the  subscrib- 
ers to  take  stock.  However,  the  usual  procedure  will  be 
to  have  a  separate  slip  to  hold  the  signature  of  each  sub- 
scriber. And  from  these  slips  a  Subscription  Register  will 
be  prepared,  this  being  a  book  containing  the  names  and 
addresses  of  the  subscribers  and  the  amounts  of  their  sub- 
scriptions. When  the  subscribers  are  many,  the  Journal 
entry  to  "Subscribers"  will  not  carry  the  name  and  sub- 
scription of  each  subscriber, — but  only  a  mere  reference  to 
the  Subscription  Register.  From  the  Subscription  Register, 
detailed  postings  will  be  made  to  each  subscriber's  account 
carried  upon  a  subsidiary  Ledger,  the  Subscription  Ledger, 
this  being  controlled  upon  the  General  Ledger  by  the 
account  of  "Subscribers."  And  when  the  payments  on 
account  of  subscriptions  are  many,  the  Cash  Book  should 
contain  a  column  for  Subscribers,  the  total  of  which  will 
be  credited  to  the  General  Ledger  account  of  Subscribers. 
As  soon  as  a  subscription  has  been  paid  in  full,  the  subscriber 
should  be  credited  upon  the  Stock  Ledger  for  the  par  of  his  stock, 
this  credit  being  made  even  though  no  certificate  of  stock  lias 
been  issued. 


CORPORATIONS-ORGANIZA TION;  RECORDS 
A  form  of  Subscription  Ledger  is  shown  below: 

=^==-— — — — -— ^  ADDRESS____ 


147 


NAME- 


Date 


No. 
Shares 

Sub- 
scribed 


At 


Total 


Calls 


No.  1 
25% 
Cash 


No.  2 

25% 

April 

1 


No.  3 

25% 

June 

1 


No.  4 

25% 

Aug. 

1 


Date 


CaUed 


Paid 


Ctlls 


No.  1 

25% 

Cash 


No.  2 

25% 

April 

1 


No.  3 

25% 

June 

1 


No.  4 
25% 
Aug 
1 


Bal- 
ance 


Re- 
marks 


') 


Instalment  List.-The  use  of  this  list  is  limited,  necessarily 
to  cases  where  the  payments  for  stock  are  called  up  in  instal- 
ments. One  separate  record  either  is  written  or  printed  from 
either  the  Subscription  List  or  the  Subscription  Register,  as  soon 
as  a  call  has  been  made  by  the  board  of  directors. 

Where  the  stock  subscriptions  are  numerous,  and  are  subject 
to  calls  extending  over  a  period  of  a  number  of  months    an 


II 


ii 


* 


148 


ADVANCED  ACCOUNTING 


account  should  be  kept  with  every  subscriber  and  with  every 
instalment,  in  a  Subscription  Ledger. 
A  form  of  Instalment  List  is  submitted  below: 


Instalment  No.    2 

Names 

No. 
Shares 

Amount 
Due 

No. 
Cert. 

Received 

Interest 

L 
F 

2 
3 

4 
5 

6 

7 

Date 

A.  Jones 

100 
200 
200 
300 
400 
500 

1,000 
2,000 
2,000 
3,000 
4,000 
5,000 

1 
2 
3 
4 
5 
6 

1,000 
2,000 
2,000 
3,000 
4,000 
5,000 

8.34 

B.  Smith... 

C.  Brown. . . 

D.  Gray.... 

L.  Wolf 

Z.  Doe 

17,000 

8  34 

Comprising  payments  of  an  instalment  of  10  per  cent  of  the 
capital  stock  of  the  Good  Luck  Trading  Company  of  Syracuse, 
New  York,  called  for  at  a  Meeting  of  the  Board  of  Directors  on 
July  5,  1921,  and  due  July  12,  1921. 

Instalment  Receipt  or  Scrip  Book.— This  book  consists  of 
receipt  forms  to  be  filled  out  and  signed  by  the  secretary  and 
treasurer  as  instalments  are  paid;  in  some  cases,  the  by-laws 
require  that  the  president  and  secretary  shall  sign  these  receipts. 
These  blanks  may  be  put  up  in  book  form,  the  receipts  being 
attached  to  stubs  therein  like  checks  in  a  check  book,  or  they 
may  be  just  loosely  padded.  When  the  last  instalment  has  been 
paid,  the  scrip  should  be  taken  up  and  certificates  of  stock  issued 
in  their  stead.  The  surrendered  receipts,  usually,  are  pasted 
back  onto  their  corresponding  stubs. 


CORPORATIONS-ORGANIZATION;  RECORDS 
A  form  of  the  above  is  shown  below: 


149 


Instalment  Scrip 
No 


Shares 


Received  from. 


.  Company 


Shares 


1st  Instalment 

per  cent. 

Received  the  above  scrip: 


AiV  * ' ".       , Dollars, 

Ihe  same  bemg  the  first  instalment  of 

"        , " Dollars, 

per  share,  on ok 

,  , ,     >-,     .    .  ^ onares 

of  the  Capital  Stock  of  the 

*u        •  J    .     " ' ' ,' Company 

the  said  shares  being  set  aside  for  the  above 

subscriber  or  his  aligns,  conditional  on  the 

fulfihnent  of  the  terms  of  the  subscription. 

President 


Secretary 


Stock  Certificate  Book.-This  is  a  bound  book  containing  the 

ration,  to  be  filled  out  and  signed  in  accordance  with  the  oro- 
visions  of  the  by-laws  of  the  corporation,  by  the  secretanr  the 
presKlent  and  the  treasurer,  or  by  the  secreta^  and  the  ^1.^'; 
Each  certificate  of  stock  is  attached  to  a  stub,  a  perforatSTne 

ment  Scrip  Book  above  shown.    Certificates  are  issued  to  those 
who  are  entitled  to  full-paid  shares.    For  convenience,  these  ce! 
tificates  are  numbered  consecutively.    A  transfer  form   usuallv 
IS  pnnted  on  the  back  of  each  certificate  in  order  to'faXtate' 
the  transfer  or  sale  of  the  stock.  lacuitate 

When  a  stock  certificate  is  surrendered  for  transfer,  it  should 

BookTwh   n  IT'"^  '^•'^  ""^  '""^  «*"'>  '^  *he  Cert  fic2 
Book  to  which  It  belongs;  the  number  and  date  of  the  new  cer! 

tificate  issued  should  be  written  on  the  stub  of  the  old  ZeTor 

cross  reference.     Infrequently,  certificates  are   found  in  JooL 

orm  m  which  event  there  is  no  stub,  the  Transfer  Jou^al  ^ 

formation  supplanting  that  ordinarily  carried  thereon. 


i 


150 


ADVANCED  ACCOUNTING 


i 


ii 


A  form  of  stock  certificate  is  shown  below: 


No. 


No.  of  Shares. 
Issued  to: 


Address . 


On: 


For: 


From  whom  transferred: 

Name : 

Address: 

On: 


No.  of 

Original  Certificate: 

No.  of 

Original  shares 

No.  of 

Shares  Transferred: 

Received  the    above    Cer- 
tificate this day 

of ,19 


Signature 


INCORPORATED    UNDER   THE  LAWS 


OF, 


No. 


.  Sharet 


THE COMPANY 


Capital  Stock 


Common  Stock — Full  paid  and  non-assessable 


This  certifies  that, 


is    the    owner    of Shares    of    the 

Capital  Stock 
of 

The Company 

Transferable  only  on  the  books  of  the  Cor- 
poration by  the  owner  hereof  in  person  or 
by  attorney,  upon  surrender  of  this  Cer- 
tificate properly  indorsed. 

In  witness  whereof,  the  President  and  th« 
Treasurer  do  hereby  sign  this  Certificate 
and  cause  it  to  be  sealed  with  the  seal  of 
the  Corporation,  this day  of 

,  19 

(Seal) 


President 


Treasurer 

Stock  Ledger  or  Book. — This  book  is  a  detailed  record  of 
the  individual  ownership  of  the  shares  of  capital  stock  of  a  cor- 
poration, which  should  be  arranged  to  comply  with  the  statute 
provisions  of  the  particular  state  under  which  th€  corporation 
came  into  being.  It  contains  one  account  with  each  stockholder 
in  which  he  is  credited  with  either  the  total  number  of  shares 
issued  to  him  or  with  both  the  total  number  of  shares  and  the 
total  par  value  thereof;  naturally,  the  latter  set-out  is  prefer- 
able to  the  former  one.    The  total  of  the  balances,  of  these  indi- 


CORPORATIONS^ORGANIZATION;  RECORDS  151 

vidual  accounts  represents  the  total  capital  stock  issued  and  out- 
standing. The  relation  of  this  total  to  the  account  of  Capital 
Stock  carried  upon  the  General  Ledger,  may  be  indicated  as 
follows : 

1.  If  the  Capital  Stock  account  records  merely  the  total  stock 
issued  and  outstanding.  The  total  of  the  balances  upon  the 
Stock  Ledger  should  always  be  the  balance  of  the  Capital 
Stock  account  upon  the  General  Ledger. 

2.  If  the  Capital  Stock  account  records  the  total  amount  of 
the  authorized  issue.  Under  this  condition,  the  above  ac- 
count will  be  offset  by  an  account  showing  the  total  amount 
of  stock  unissued,  as  a  debit  balance;  and  the  difference 
between  these  two  accounts,  at  any  time,  will  represent  the 
amount  of  capital  stock  issued  and  outstanding.  In  turn, 
this  net  balance  always  should  agree  with  the  total  of  the 
balances  upon  the  Stock  Ledger. 

The  above  two  possibilities  do  not  take  into  consideration 
the  Item  of  treasury  stock  which  may  appear  upon  the  General 
Ledger.  Smce  treasury  or  trustee  stock  remains  under  the  con- 
trol of  the  company,  the  account  with  it  may  be  kept  upon  the 
General  Ledger  only.  And  under  the  second  possibility  above 
when  treasury  stock  exists,  a  further  adjustment  must  be  made 
m  reconcilmg  the  total  of  the  balances  upon  the  Stock  Ledger 
with  the  account  of  Capital  Stock  upon  the  General  Ledger 

To  permit  the  ready  balancing  of  the  Stock  Ledger,  in  fact  to 
make  this  Ledger  self-balancing,  it  is  customary  to  carry  a  siim- 
mary  account  upon  the  Stock  Ledger,  as  the  first  account  therein 
which,  at  all  times,  shows  the  total  number  of  shares  issued,  and 
their  total  par  value  if  values  are  recorded  as  well  as  number 
of  shares.  The  items  in  this  account  will  be  found  upon  the  side 
opposite  from  that  upon  which  appear  each  of  the  detail  balances 
of  the  numerous  stockholders;  in  other  words,  in  the  summary 
account,  the  balance  will  be  on  the  debit  side. 

A  specially  ruled  Stock  Ledger  is  preferable'  although  not  ab- 
solutely required  unless  the  law  specifies  a  special  ruling  In 
Its  simplest  form,  the  standard  double  column  Ledger  ruling 
will  suffice.  On  the  credit  side  of  each  account  are  shown  the  date 
and  number  of  the  stock  certificate,  the  source  from  whence  it 
came,  the  number  of  shares,  and  the  face  value.  The  source 
either  is  original  (as  where  original  subscriber)  or  the  name  of 


152 


ADVANCED  ACCOUNTING 


CORPORA  TIONS-ORGANIZA  TION :  RECORDS 


153 


I 


■ 

i 


the  person  from  whom  the  certificate  of  stock  was  transferred. 
When  stock  is  transferred,  the  stub  of  the  old  certificate  should 
show  the  name  of  the  person  to  whom  the  transfer  is  made, 
and  the  number  of  the  new  certificate  issued  to  the  transferee ; 
the  stub  of  the  new  certificate  should  show  the  name  of  the 
person  from  whom  it  came.  In  this  way,  a  cross  index  is  se- 
cured by  means  of  which  one  may  trace  the  stock  forward  or 
backward.  The  person  who  transfers  stock  will  have  indicated 
upon  the  debit  side  of  his  Stock  Ledger  account,  the  name  of 
the  person  to  whom  the  transfer  was  made,  the  number  of  the 
stock  certificate  surrendered,  the  number  of  shares  transferred, 
and  the  face  value  of  the  shares  transferred. 

In  many  instances,  the  total  number  of  shares  indicated  upon 
the  surrendered  certificate  of  stock  will  not  be  transferred  com- 
pletely, but  only  a  portion  thereof.  In  such  case,  the  balance 
representing  the  retained  portion  should  be  charged  upon  the 
Stock  Ledger  to  "self,"  and  be  credited  for  the  same  amount  for 
the  certificate  issued  to  cover  the  shares  retained.  In  other 
words,  whenever  a  transfer  is  made,  the  old  certificate  must  be 
cancelled  entirely  and  be  charged  upon  the  Stock  Ledger,  and 
a  like  number  of  shares  must  be  issued  and  be  credited  thereon 
unless  treasury  stock  or  trustee  stock  is  involved.  As  indicated 
above,  treasury  or  trustee  stock  remains  under  the  company's 
control  with  the  result  that  the  account  therewith  may  be  carried 
only  upon  the  regular  records.  Only  this  stock  which  actually 
has  been  transferred  out  should  be  covered  by  stock  certificates. 

The  New  York  law  requires  (S.  C.  L.,  Art.  2)  that  every  stock 
corporation  shall  keep: 

A  book  to  be  known  as  a  stock  book,  containing  the  names,  alpna- 
betically  arranged,  of  all  persons  who  are  stockholders  of  the  corpora- 
tion, showing  their  places  of  residence,  the  number  of  shares  of  stock 
held  by  them  respectively,  the  time  when  they  respectively  became 

the  owners  thereof,  and  the  amount  paid  thereon The 

stock  book  of  every  such  corporation  shall  be  open  daily,  during  at 
least  three  business  hours,  for  inspection  by  any  judgment  creditor  of 
the  corporation;  or  by  any  person  who  shall  have  been  stockholder  of 
record  in  such  corporation  for  at  least  six  months  immediately  preceding 
his  demand;  or  by  any  person  holding  stocks  of  such  corporation  to  an 
amount  equal  to  five  per  centum  of  all  its  outstanding  shares;  or  by 
any  person  thereunto  in  writing  authorized  by  the  holders  of  stock  of 
such  corporation  to  an  amount  equal  to  five  per  centum  of  all  its  out- 


standing shares.     Persons  so  entitled  to  inspect  stock  books  may  make 
extracts  therefrom.     No  transfer  of  stock  shall  be  valid  as  against  the 
corporation,  its  stockholders  and  creditors  for  any  purpose 
until  it  shall  have  been  entered  in  such  book  as  required  by  this  sec- 
tion, by  an  entry  showing  from  and  to  whom  transferred. 

Failure  to  comply  with  this  law  entails  a  fine  to  be  paid  the 
State  in  the  amount  of  $50.00  a  day  for  every  day  the  corpora- 
tion neglects  or  fails  to  do  so. 

If  more  than  one  class  of  capital  stock  is  issued,  usually,  there 
will  be  one  or  more  Stock  Ledgers  for  each  class  of  stock.  In 
large  corporations,  loose-leaf  or  card  forms  of  Stock  Ledgers  fre- 
quently are  used.  In  connection  therewith,  a  tickler  card  file 
frequently  is  found,  being  used  as  a  means  of  check  against  the 
Ledger  accounts,  and  as  a  basis  for  making  up  mailing  lists 
for  the  circulation  of  reports,  meeting  notices,  and  the  payment 
of  dividends.  Each  such  list  must  be  checked  in  sufficient  de- 
tail so  it  agrees  absolutely  with  the  actual  facts  as  recorded; 
and  to  make  doubly  certain  that  errors  will  be  eliminated,  it  is 
customary  to  have  each  such  list  certified  by  the  secretary  as 
being  correct.  Each  card  in  the  tickler  file  would  hold  the  name 
of  a  stockholder,  his  address,  and  the  number  of  shares  of  each 
class  of  stock  held. 
A  form  of  Stock  Ledger  is  shown  below: 


Name  of  Stockholder 


Date 
of 

Trans- 
fer 
of 

Shares 
by 

Above 


Address 


Trans- 
fer 
No. 


To 
Whom 
Trans- 
ferred 


L 
F 


Certificate 
Surrendered 


Cert. 
Nos. 


No. 
Shares 


Date 

of 
Acqui- 
sition 

of 
Shares 


Prom  Whom 
Transferred 
(If  original 

issue, 
state  such) 


L 
F 


Certificate 
Issued 


Cert. 
No. 


No. 
Shares 


Bal- 
anoe 
Cr. 


1 


154 


ADVANCED  ACCOUNTING 


Stock  Journal. — In  certain  states  all  stock  transfers  must  be 
recorded  in  a  Transfer  Journal,  which  will  consist  of  blank 
assignments  to  be  filled  out  and  signed  by  those  who  are  trans- 
ferring, or  by  their  attorneys.  Again,  this  Journal  may  be  used 
by  a  corporation  whose  stock  is  active,  to  summarize  daily  all 
the  stock  transactions  taking  place  both  at  the  office  and  at 
the  offices  of  the  transfer  agents  so  that  postings  may  be  made 
quickly  and  accurately  to  the  Stock  Ledger.  Money  amounts 
are  not  used  therein. 

In  the  form  below,  one  will  notice  the  possibility  of  charging 
a  stockholder  with  the  shares  sold,  and  of  crediting  the  pur- 
chaser; or  if  a  certificate  of  100  shares  is  to  be  split  up  into 
four  certificates  of  25  shares  each,  the  original  would  be  charged 
to  the  stockholder  and,  in  turn,  he  will  be  credited  with  the  same 
number  of  shares  on  four  certificates  carrying  four  consecutive 
numbers. 

Original  stock  issues  may  be  recorded  herein;  when  done,  the 
entries  therefor  usually  are  made  in  red  ink  so  they  will  be 
clearly  distinguishable  from  those  relating  to  transfers.  If  more 
than  one  class  of  stock  is  issued,  a  separate  Transfer  Journal 
may  be  found  for  each  class. 

A  form  of  Stock  Journal  is  shown  below: 


Date 


STOCK  CERTIFICATES  SURRENDERED 

STOCK    CERTIFIC^^TES    ISSUED 

Name 

of 
Stock 
Holder 

L 
F 

Signa- 
ture 
of 
Attorney 

No. 

of 

Cert. 

No. 

of 

Shares 

Total 
Shares 

To 

Whom 
Trans- 
ferred 

L 
F 

Resi- 
dence 

No. 

of 

Cert. 

No. 

of 

Shares 

Total 
Shares 

CORPORATIONS-ORGANIZATION;  RECORDS  155 

Stock  Transfer  Book.— The  requirements  of  the  statutes  of 
the  different  states  are  dissimilar  as  relates  to  the  Stock  Trans- 
fer Book,  a  book  to  be  kept  by  every  corporation  or  its  trans* 
fer  agent.  In  New  York,  the  form  used  must  be  one  approved 
by  the  state  comptroller.  Such  a  record,  approved  as  to  form, 
is  shown  below,  this  being  obtainable  in  most  stationery  stores. 


Date 


Stock  Transfer  Book 


Serial 
Number 

of 
Cancelled 
Certificate 


No. 
of 

Shares 


By  Whom 
Surren- 
dered 


To  Whom 
Issued 


Serial 

Number 

of 

New 

Certificate 


No. 
of 
Shares 


Number  and  Face  Value  of  Stamps 


2^ 


H 


lOfS 


20^ 


SOff 


$1 


92 


110 


$20 


Value 


The  section  at  the  right  of  the  form  relates  to  the  number  and 
value  of  the  adhesive  stamps  which,  by  law,  must  be  affixed. 
In  New  York,  there  is  a  tax  payable  on  the  transfer  of  capital 
stock.  No  transfer  tax  is  required  on  the  original  issue  of  the 
stock,  this  being  necessary  only  in  connection  with  all  trans- 
fers of  a  beneficial  interest.  The  requirements  of  the  law  are  as 
follows  (Tax  Law;  Art.  12,  sec.  270) : 

There  is  hereby  imposed  and  there  shall  immediately  accrue  and  be 

collected  a  tax       ....  on the  transfer  of  any  stock,  on 

each  hundred  dollars  of  face  value  or  fraction  thereof,  two  cents,  except 
in  cases  where  the  shares  or  certificates  of  stock  are  issued  without  desig- 
nated monetary  value,  in  which  cases  the  tax  shaU  be  at  the  rate  of 
two  cents  for  each  and  every  share  of  such  stock The  pay- 
ment of  such  tax  shall  be  denoted  by  an  adhesive  stamp  or  stamps 


» 


I 


156 


ADVANCED  ACCOUNTING 


When  an  old  certificate  is  surrendered  to  a  company  whose 
rules  demand  a  transfer  on  its  books  in  person  or  by  duly  author- 
ized attorney,  the  individual  or  his  attorney  presents  the  certifi- 
cate with  the  form  of  assignment  on  the  back  filled  out  or  hav- 
ing attached  a  separate  assignment  paper.  The  transfer  is  re- 
corded in  the  Transfer  Book.  If  the  signature  be  not  known  to 
the  transfer  agent,  it  should  be  guaranteed  by  a  responsible 
person, — a  bank,  a  trust  company,  or  a  broker.  The  signatures 
on  the  old  certificate  first  are  mutilated  before  pasting  it  back 
on  the  stub  from  which  it  was  detached  originally.  Next,  a 
new  certificate  is  issued  in  accord  with  the  terms  of  the  assign- 
ment to  replace  the  old  one.  The  holder  of  the  new  certificate 
will  receipt  therefor  in  the  same  manner  as  did  the  holder  of 
the  old  one. 

Bond  Register. — Accounting  problems  arise  in  connection 
with  an  issue  of  bonds  which  are  similar  to  those  arising  in  con- 
nection with  an  issue  of  stock,  at  least  in  many  respects.  Briefly, 
without  discussing  the  subject  of  bonds  in  any  way  at  this  point 
since  one  chapter  is  reserved  later  therefor,  it  is  sufficient  to 
state  that  in  the  case  of  registered  bonds  a  record  of  individual 
ownership  usually  is  kept  in  a  Bond  Register  which,  in  ruling, 
is  similar  to  the  record  kept  of  stockholders.  This  record  would 
be  kept  even  if  bonds  are  registered  only  as  to  principal. 

New  York  Stock  Exchange. — The  New  York  Stock  Exchange 
is  an  association  of  brokers  maintained  for  buying  and  selling 
securities  which  have  been  listed  officially  by  the  Exchange,  thia 
activity  being  conducted  for  a  commission  remuneration.  The 
commission  charged  upon  both  purchases  and  sales  is  one-eighth 
of  one  per  centum  of  the  par  value  of  the  security  dealt  in. 

Before  the  Exchange  will  handle  any  security,  it  must  be  listed 
in  a  formal  manner  by  what  is  known  as  the  Committee  on 
Stock  List.  If  a  corporation  wishes  to  list  its  stock,  it  makes 
formal  application  to  do  so  and,  as  part  of  such  application, 
a  statement  must  be  made  relative  to  the  following: 

1.  Organization  and  purpose  of  the  corporation. 

2.  Amount  of  its  capital. 

3.  Object  behind  the  stock  issue. 

4.  Current  financial  condition  and  earnings. 


CORPORATIONS-ORGANIZATION;  RECORDS  157 

Likewise,  in  connection  therewith,  copies  of  the   following 
must  be  submitted: 

1.  Certificate  of  incorporation. 

2.  By-laws. 

3.  Resolutions  of  stockholders  and  directors  as  to  the  stock 
issue. 

4.  Contracts  and  leases  relating  to  the  issue  of  stock. 

All  of  this  information  must  be  certified  to  as  correct  by  the 
officers  of  the  corporation.    Because  of  the  above  requirements 
coupled  with  the  work  of  the  Committee  on  Stock  List,  question- 
able issues  of  securities  are  barred  from  being  listed  on  the  Ex- 
change. 

Many  other  rules  are  enforced  by  the  Exchange  relating  to 
a  number  of  items  too  numerous  to  mention,  but  perhaps  one 
of  interest  in  connection  with  the  present  work  is  to  the  effect 
that  certificates  of  stock  or  bonds  which  either  are  printed  or 
lithographed  cannot  be  dealt  in  upon  the  Exchange;  such  certi- 
ficates must  be  printed  from  steel  plates  by  a  firm  of  approved 
engravers.  ^^ 

.y.^T\uTf  '**'  P™P«rty-It  was  noticed  in  the  last 
chapter  that  the  capital  stock  of  a  corporation  may  be  paid  for 
m  property,  in  money,  or  in  services.  When  stock  is  paid  for 
in  cash,  the  accounting  involved  is  decidedly  simple  so  far  as 
valuation  is  concerned.    On  the  other  hand,  when  stock  is  paid 

Theoretically,  at  least,  the  valuation  given  services  and  pro^: 
erty  in  the  fair  and  impartial  honest  judgment  of  the  directors 
must  be  equal  to  the  stock  given  therefor.    Especially  IthsS 
m  the  case  of  property  since  its  valuation  will  lie^  "sua  y  ^^ 
the  discretion  of  the  directors  unless  fraud  is  present  whereaL 

tn^d- ir^der  ^^^  -^^  -'' ''  --  '^  ---- 

If  property  has  a  certain  market  value  which  is  recognized 

n  the  community,  or  if  the  value  thereof  is  determinSe  f  om 

he  original  purchase  records,  the  problem  is  not  so  diffi  ul  Tr 

the  accountant.    But  where  the  property  is  such  that  S  via 

tion  IS  a  matter  of  judgment,  the  accountant  must  be  on  ^ard 

not  to  commit  himself,  when  opening  the  books,  to  any  eS 


\t     I'V 


k 


t 


■'t 


li    > 


158 


ADVANCED  ACCOUNTING 


in  seeming  to  justify  the  valuation  figures  handed  him.  In  other 
words,  he  should  assume  no  responsibility  for  such  valuation. 
The  explanation  of  the  entry  should  be  to  the  effect  that  the; 
valuation  is  in  accord  with  the  directors'  authorization  as  ex- 
pressed in  the  minutes.  Perhaps  the  valuation  will  be  that 
fixed  by  the  stockholders  or  by  an  appraisal  company. 

The  following  further  points  should  be  observed  in  booking 
property  values: 

1.  A  general  account  holding  tangible  values  (also  intangible 
values)  should  not  be  used.  In  other  words,  good-will,  or 
a  like  intangible  asset  should  not  be  merged  with  a  plant 
account. 

2.  If  the  properties  taken  over  are  not  indicated  in  detail, 
as  to  separate  item  valuations,  a  Plant  and  Sundry  Assets 
account  may  be  used  to  hold  the  charge  when  the  properties 
are  turned  over  in  payment  of  a  subscription  to  stock. 
Later,  when  a  valuation  has  been  placed  upon  the  separate 
items  of  property,  separate  asset  accounts  may  be  debited 
and  the  collective  account  suggested  above  closed. 

3.  If  all  the  details  are  present  in  the  bill  of  sale  covering  the 
specific  valuation  of  the  detail  assets  secured,  the  Plant 
and  Sundry  Assets  account  really  is  unnecessary. 

Problem.— For  illustrative  purposes,  in  this  connection,  study  the  solu- 
tion and  comment  covering  the  following  simple  problem  taken  from  a  New 
York  C.  P.  A.  examination.  The  Prosperous  Company  is  organized  under 
the  laws  of  the  State  of  New  York  to  conduct  a  manufacturing  business. 
The  authorized  capital  stock  is  $500,000.00,  divided  into  $250,000.00 
common  and  $250,000.00  preferred  stock,  par  value  of  shares  $100.00.  Five 
incorporators  subscribe  each  for  one  share  of  common  stock  at  face  value. 
John  Peters,  one  of  the  incorporators,  purchases  from  three  manufacturing 
companies  their  complete  plants  for  $499,500.00,  and  transfers  said  plants 
to  the  Prosperous  Company  for  the  remaining  $499,500.00  of  common  and 
preferred  stock  and  $100,000.00  of  the  first  mortgage  bonds  out  of  a  total 
issue  of  bonds  amounting  to  $150,000.00,  leaving  $50,000.00  of  bonds  in 
the  treasury.  The  incorporators  then  pay  in  cash  for  their  respective 
subscriptions. 

The    individual    assets    acquired    are  as  foUows:    land    and  buildings 
$75,000.00;   plant   and   machinery,    $200,000.00;    tools,    equipment    and 
fixtures,    $50,000.00;    inventories,  $100,000.00;  accounts    receivable 'good 
$28,000.00,  doubtful,  $5,000.00;  cash,  $12,000.00.  ' 

Prepare:(a)  Opening  entries  for  the  books  of  the  Prosperous  Company 

(b)  Initial  Balance  Sheet  showing  the  company's  financial  con- 
dition, 


$250,000.00 
250,000.00 


CORPORATIONS^ORGANIZATION;  RECORDS  Ifi® 

SoluHon.~The  first  step  is  to  book  the  authorized  stock  issue,  preceding 
same  with  a  formal  heading:  * 

THE  PROSPEROUS  COMPANY 
A  Corporation  Organized 

Under  the  Laws,  of 

The  State  of  New  York 

With  an  Authorized 

Capital  Stock  of 

$500,000.00 

Consisting  of 

$250 ,  000 .  00  Preferred  Stock 

$250 ,  000 .  00  Common  Stock 

Unissued  Capital  Stock— Preferred, 

Unissued  Capital  Stock— Common' 

To— Authorized  Capital  Stock— Preferred, 
Authorized  Capital  Stock— Common,' 

The  next  step  is  to  make  entry  of  the  subscriptions  of  the  five  incorpor- 
ators  for  one  share  each  of  the  common  stock: 

Subscribers  to  Capital  Stock— Common,  $500  00 

To— Subscriptions  to  Capital  Stock— Common,  $500  00 

Next,  it  is  necessary  to  book  the  take-over  of  the  assets  from  John  Peters 
A^u     Tl!  "'*''^  *^'  """  °^  '^'  ^"'^''^^  ^^"*  ^^^^^'^^  «^  PI^"t  and  Sundry 
in  this  entry  but  m  opemng  entnes  of  this  kind,  it  is  desirable  to  make  use 

1.  These  assets  must  be  appraised,  and 

2.  Because  the  element  of  good-will  is  a  frequent  factor  to  demand  con- 
sideration when  a  going  business  is  taken  over. 

By  conforming  to  this  practice,  the  books  may  be  opened  immediatelv 
whereas,  action  by  the  board  of  directors  relative  to  the  ^aluatio""f  ^^^^^^^^ 
assets  may  be  deferred  untU  convenient  to  take  up  the  matter 


$250,000.00 
250,000.00 


$599,500.00 


$599,500.00 


Plant  and  Sundry  Assets, 
To — John  Peters,  Vendor, 

To  record  purchase  of  sundry  assets  per  bill  of 
sale  on  file  for: 
Preferred  Stock,  $250 ,  000 .  00 

Common  Stock,  249 ,  500 .  00 

Mortgage  Bonds,  100.000.00 

As  Above,  599,500.00 

The  next  entry  covers  the  issue  of  stock  and  bonds  in  full  payment  of 
the  properties  taken  over.    A  specific  discussion  of  bond  entries  fsTefeld 

preslnt.  ""  ^''  '"*'^  ^"""'^^  ^^^^^  ^'^'  ^^^--^t  ^orThe 


ti 


160 


ADVANCED  ACCOUNTING 


W 


$599,500.00 


$500.00 


$500.00 


John  Peters,  Vendor, 

To— Unissued  Capital  Stock— Preferred,  $250 ,  000 .  00 

Unissued  Capital  Stock — Common,  249 ,  500 .  00 

First  Mortgage  5  per  cent  Bonds,  100,000 .00 
Next,  the  incorporators  pay  in  their  subscriptions  in  cash: 

Cash  (Cash  Book),                     '  $500.00 
To — Subscribers  to  Capital  Stock — Common, 

following  which,  stock  certificates  are  issued  requiring  for  entry 
Subscriptions  to  Capital  Stock — Common,  $500.00 

To — Unissued  Capital  Stock — Common, 

The  last  and  final  entry  covers  the  placement  of  the  specific  assets  ac- 
quired upon  the  books  in  accord  with  the  action  of  the  l)oard  of  directors 
in  respect 'thereto.  Since  accounts  receivable  in  the  amount  of  $5,000.00, 
are  considered  doubtful,  it  would  be  reasonable  to  assume  that  a  Reserve 
for  Bad  Debts  account  of  an  equal  amount  was  set  up  on  the  books.  Also, 
note  the  item  of  good-will  for  which  an  account  is  established.  This  is 
perfectly  proper  under  the  present  circumstances  in  that,  since  the  con- 
cerns taken  over  were  going  concerns  a  certain  amount  of  good-will  may 
be  assumed  as  being  possessed  by  them.  Since  good-will  is  a  measure  of 
earning  capacity,  only  an  established  business  can  possess  it.  Had  there 
been  no  take  over  of  a  going  concern,  but  only  an  embryo  business  com- 
menced, no  good-will  rightly  could  be  assumed  to  be  in  existence.  A  further 
discussion  of  good-will  is  reserved  for  the  chapter  on  consolidations.  The 
entry  necessary,  as  a  final  step,  is  as  follows: 

Land  and  Buildings,  $  75,000.00 

Plant  and  Machinery,  200 ,  000 .  00 

Tools,  Equipment,  and  Fixtures,  50,000.00 

Good-will,  134,500.00 

Inventories,  100 ,  000 .  00 

Accounts  receivable,  33 ,  000 .  00 

Cash,  12,000.00 
To — Reserve  for  Bad  Debts, 
Plant  and  Sundry  Assets, 

To  complete  the  solution  of  this  problem,  it  is  necessary  only  to  submit 
the  opening  Balance  Sheet.    This  is  as  follows: 

THE  PROSPEROUS  COMPANY 
BALANCE  SHEET 

as    at 


$  5,000.00 
590,500.00 


Assets 


Capital  Assets: 


Land  and  Buildings, 

Plant  and  Machinery, 

Tools,  Equipment,  and  Fixtures, 

Good-will, 

Total  Capital  Assets, 


$  75,000.00 
200,000.00 
50,000.00  $325,000.00 

134,500.00 

$459,500.00 


ni 


CORPORATIONS-ORGANIZATION;  RECORDS 


161 


Current  Assets: 
Inventories, 

Accounts  Receivable,  $33 ,  000 .  00 

Less:  Reserve  for  Bad  Debts,  5,00000    28,000.00 


$100,000.00 


Cash, 

Total  Current  Assets, 
Total  Assets, 


12,500.00 


Liabilities 


140,500.00 
$600,000.00 


Capital  Stock: 

Capital  Stock— Preferred, 
Capital  Stock — Common, 

Total  Authorized,  Issued  and  Outstandine 
Capital  Liabilities: 

*  Tl5of(K)0  wT  ^  ^'"  ''^''*  ^''°'^^  (Authorized 
Total  Liabilities, 


$250,000.00 
250,000.00 


$500,000.00 

100,000  00 
$600,00000 

Transfer  of  the  Business  of  a  Sole  Trader  to  a  Corpora^ 
tion.~Nearly  all  corporations  have  their  inception  based  upon 
some  previously  existing  business.  An  individual  starts  in  busi- 
ness on  a  small  scale.  As  his  activity  expands,  he  needs  more  cap- 
ital.  This  capital  he  secures  in  the  following  ways,  one  or  more: 

1.  J5y  borrowing  money. 

2.  By  inducing  some  one  to  go  into  partnership  with  him 

3.  By  inducing  at  least  two  people  to  join  with  him  in  form- 
mg  a  corporation;  perhaps  these  two  will  take  only  a  mini- 
mum  number  of  shares  commensurate  with  the  help  needed 

ihll  f  h      T  ^  P^^^^^^^^P^  *h«  l^^ter  may  succeed  to  the  end 
that  the  partners  cannot  control  and  develop  it  as  they  should 
The  result  IS  that  a  corporation  is  formed  to  secure  both  more 
capital  and  the  protection  of  a  limited  liability 

Again  two  or  more  existing  business  concerns  may  combine  or 
consolidate  into  a  corporation.  A  sole  trader  may  coZne  4h 
another  sole  trader  in  the  formation  of  a  corporation  he  mav 
combine  with  a  partnership  or  with  a  corporatl  in  tLioZZ 
tion  of  a  new  corporation;  a  partnership  may  combine  withT 
other  partnership  or  with  a  corporation'^to  formTnew  cZZ 
tion;  two  or  more  partnerships  and  corporations  may  comC 
two  or  more  corporations  may  combine  In  fart  iL  IV 
variations  as  to  the  original  coLtituent  units  eoS^^^^  ^^ 
formation  of  a  new  corporation  are  many.  ^  *^^ 


162 


ADVANCED  ACCOUNTING 


Some  of  the  problems  encountered  in  merging  and  consolidat- 
ing with  the  end  in  view  of  forming  a  new  corporation  are  diffi- 
cult and  intricate,  and  a  discussion  of  these,  exclusive  of  certain 
fundamentals,  of  necessity,  must  be  omitted  until  a  later  time 
when  the  student  shall  have  gained  a  certain  familiarity  with 
underlying  corporate  principles  of  accounting.  Therefore,  it  ia 
the  purpose  at  the  present  time  to  consider  only  the  more  rudi- 
mentary elements  involved  in  the  above,— namely,  the  transfer 
of  the  business  of  a  sole  trader  or  partnership  to  a  corporation. 

Problem.— The  Jones  Manufacturing  Company  was  incorporated  under 
the  laws  of  the  State  of  New  York  to  acquire  and  conduct  the  businow, 
heretofore  operated  by  H.  B.  Jones.  The  authorized  capital  stock  of  the 
corporation  is  $700,000.00,  divided  into  $400,000.00  preferred  stock  and 
$300,000.00  common  stock,  each  class  of  the  par  value  of  $100.00  per  share. 
The  preferred  stock  is  preferred  as  to  assets;  likewise,  it  is  entitled  to  re 
ceive  an  8  per  cent  dividend  before  any  dividends  are  paid  to  the  common 
stock,  but  after  the  common  stock  has  received  an  8  per  cent  dividend,  both 
cWs  of  stock  shall  then  participate  equally  in  whatever  dividends  are 
to  be  distributed  from  the  surplus. 

The  foUowing  is  a  Trial  Balance  drawn  from  the  books  of  H.  B.  Jon«.. 
as  of  December  31,  1920,  which  is  assumed  to  be  correct: 


Land, 

Buildings, 

Machinery  and  Equipment, 

Furniture  and  Fixtures, 

Finished  Product, 

Product  in  Process, 

Materials, 

Supplies  and  Sundries, 

Accounts  Receivable, 

Notes  Receivable, 

Mortgage  Payable, 

Notes  Payable, 

Accounts  Payable, 

Reserve  for  Depreciation  of  Capital  Assets, 
Capital, 


$  20,000.00 

30,000.00 

16,500.00 

2,000.00 

10,400.00 

13,800.00 

8,000.00 

1,000.00 

23,000.00 

6,000.00 

$  12,000.00 

3,400.00 

22,000.00 

45, 000. (K) 

48, 300.  (K) 

$130,700.00  $130,700.00 

In  the  corporate  enterprise,  Jones  is  joined  by  his  wife  who  invests  in 
the  company  the  same  amount  of  capital  as  Jones  gets  common  stock 
liJcewise,  his  brother  introduces  therein  $50,000.00.     The  price  the  cor' 
S".    K  '"^r'  '^  ^^^  '''  ''''  P^^P^^*^^«  *^ken  over  i^s  $I5^5)0  (^ 
at:pV:omm?nl^^^^^^^^    ''  '''  -'^-'-'  ^''  '^^  ^^^  ^-P-to^ 


CORPORATIONS^ORGANIZATION;  RECORDS  163 

The  stock  is  issued  on  January  3,  1921,  and  on  January  15,  the  directors 
hold  a  meeting  at  which  time  the  following  is  agreed  upon,  as  based  upon 
replacement  values: 

1.  Value  of  land  to  be  carried  at  $28,000.00. 

2.  Value  of  buildings  to  be  carried  at  $64,000.00. 

3.  Value  of  machinery  and  equipment  to  be  carried  at  $18,500.00.    ' 

4.  Value  of  furniture  and  fixtures  to  be  carried  at  $2,500.00. 

The  reserve  for  depreciation  of  capital  assets  as  carried  in  the  Trial 
Balance  is  to  be  reduced  by  the  amount  of  increases  shown  above 
except  as  to  land.  The  balance  of  the  take-over  price  is  to  be  set  up 
on  the  books  as  good-will. 

Required:  Journal  entries  to  record  the  above  on  the  books  of  the  Jones 
Manufacturing  Company. 

Solution.— An  elaborate  discussion  of  this  solution  is  unnecessary,  in 
that  the  explanation  of  each  entry  is  deemed  sufficient. 

Usual  Pro-Forma  Entry  (Omitted) 

(1) 

Plant  and  Sundry  Assets, 

To — H.  B.  Jones,  Vendor, 
To  record  acquisition  of  sundry  properties 
and  assets,  subject  to  certain  habilities  and 
reserves;  in  general,  subject  to  decision  of 
Board  of  Directors  concerning  the  valu- 
ation of  detail  items  of  assets. 

H.  B.  Jones,  Vendor,  $150,000.00 

To — Capital  Stock — Preferred, 
Capital  Stock — Common. 
To  record  issue  of  stock  to  vendor,  preferred 
stock  being  issued  for  intrinsic  value  of 
properties  and  assets  acquired,  namely: 
Book  value  of  assets,  $130 ,  700 .  00 

Less:  Reserve,  45,000.00 

Balance,  $  85,700.00 

Less:  Liabilities,  37,400.00 

Net  Total— Preferred  Stock,   $  48,300.00 
Total,  all  stock,  $150 ,  000 .  00 

Total,  Preferred  Stock,  48 ,  300 .  00 


$150,000.00 


$150,000.00 


$  48,300.00 
101,700.00 


Net  Total— Conmion  Stock,    $101, 700  00 

(3) 


Subscribers  to  Capital  Stock — Common, 


To — Subscriptions  to  Capital  Stock — Common, 

To  record  subscriptions  of  wife  and  brother, 
as  follows: 


$151,700.00 


$151,700.00 


Wife, 
Brother, 

Total, 


$101,700.00 
50,000.00 

$151,700.00 


1 


it  I 


164 


ADVANCED  ACCOUNTING 


(4) 


t 


■I 


Cash, 
To- 


$151,700.00 


-Subscribers  to  Capital  Stock — Common, 

To  record  cash  received  on  account  of  sub- 
scriptions. 


$151,700.00 


(5) 


Subscriptions  to  Capital  Stock — Common, 
To — Capital  Stock — Common, 
To  record  issue  of  stock  certificates  to  above 
subscribers. 


(6) 


$151,700  00 


$151,700.00 


Land,                                                                         $  28,000.00 

Buildings, 

64,000.00 

Machinery  and  Equipment, 

18,500.00 

Furniture  and  Fixtures, 

2,500.00 

Good-will, 

20,700.00 

Finished  Product, 

10,400.00 

Product  in  Process, 

13,800.00 

Materials, 

8,000.00 

Supphes  and  Sundries, 

1,000.00 

Accounts  Receivable, 

23,000.00 

Notes  Receivable, 

6,000.00 

To — Mortgage  Payable, 

$12,000.00 

Notes  Payable, 

3,400.00 

Accounts  Payable, 

22,000.00 

Reserve  for  Depreciation, 

8,500.00 

Plant  and  Sundry  Assets, 

150,000.00 

To  record  closing  account  of  Plant  and 

Sundry  Assets,  and  aet  up  on  the 

books  the  individual  asset  and  liabil- 

ity accounts,  for  net  properties  ac- 

quired and  assumed,  based  upon  a 

valuation  arrived  at  by  the  Board  of 

Directors  on  January  15,  1921. 

The  amount  of  the  good-will  is  calcu- 

lated as  follows: 

Cost  of  good-wiU,            $101 ,  700 .  00 

Deduct: 

Application    to    incre^ise 

land  value,                      $  8 ,  000 .  00 

Application    to    increase 

value  of  other  assets: 

Buildings,        $34,000.00 

CORPORATIONS-ORGANIZATION;  RECORDS  165 


Machinery 
and  Equip- 
ment, 

Furniture  and 
Fixtures, 


2,000.00 

50000  36,500.00 


App.  to  reduce  reserve,        36,50000  $81,000.00 
Balance,  net  good-will,  $20,700  00 

Procedure  by  Vendor  Upon  the  Sale  of  the  Business  of  a 
Sole  Trader  or  of  a  Partnership  to  a  Corporation.— Thus  far 
in  the  present  chapter,  there  has  been  discussed  only  the  pro- 
cedure of  the  vendee  (the  corporation)  when  either  the  business 
of  a  sole  trader  or  of  a  partnership  has  been  transferred  to  a 
corporation.  Since  a  definite  course  should  be  followed  by  the 
vendor  under  each  of  these  conditions,  it  cannot  be  amiss  to  take 
the  time  here  to  present  this  angle  of  the  case.  In  this  connec- 
tion, the  student  should  recall  to  mind  the  procedure  to  be  fol- 
lowed where  the  net  assets  of  a  sole  trader  are  transferred  to  a 
partnership  since,  by  so  doing,  the  present  discussion  will  not  be 
absolutely  new  and  strange. 

Where  a  sale  lias  been  made  to  a  corporation,  the  course  to 
follow,  necessarily,  will  depend  somewhat  upon  how  the  deal  was 
effected.  In  general,  a  formal  bill  of  sale  becomes  the  basis 
of  the  arrangement  in  which  are  set  out: 

1.  The  assets  to  be  transferred. 

2.  The  liabilities  to  be  assumed. 

3.  The  valuations  agreed  upon. 

4.  The  manner  of  paying  the  vendor. 

The  general  possibilities  of  procedure  herein  considered  may 
be  summarized  roughly  about  as  follows: 
1.  Valuation  in  take-over: 

a.  The  valuation  at  which  the  take-over  is  made  differs  in 
respect  of  the  individual  assets  from  that  shown  on  the 
books  of  the  vendor.  Where  the  assets  are  transferred 
at  a  valuation  different  from  that  shown  on  the  vendor's 
books,  a  two-way  possibility  exists: 

i.  The  assets  are  transferred  at  a  valuation  greater 

than  the  book  figures, 
ii.  The  assets  are  transferred  at  a  valuation  less  than 
the  book  figures. 


166 


ADVANCED  ACCOUNTING 


Is 

i 
II 


In  either  event,  the  first  step  necessary  is  to  adjust  the 
book  figures  to  the  new  valuations,  and  absorb  the  dif- 
ference, representing  a  profit  or  loss,  in  the  Profit  and 
Loss  account;  here  there  is  a  realized  profit  or  loss  which 
makes  the  absorption  through  the  Profit  and  Loss 
account  in  order.  The  further  treatment  will  depend, 
generally,  upon  the  variation  of  conditions  as  indicated 
below  in  (2)  and  (3). 

b.  The  total  assets  transferred  on  the  basis  of  a  lump  sum 
valuation,  including  good-will.  Hereunder,  the  transfer 
will  be  for  a  lump  sum  in  excess  of  the  book  valuation. 
The  procedure  necessary  must  be  varied  to  a  slight  degree 
because  such  excess  cannot  be  attributed  as  being 
attached  to  any  specific  asset  or  assets  disposed  of. 
One  assumes,  natm-ally,  that  the  vendee  has  purchased 
the  asset  of  good-will  in  addition  to  the  tangible  assets 
under  process  of  sale.  Especially  is  this  true  in  the  sale 
of  a  going  concern.  The  first  step  necessary  would  be 
to  book  the  excess  to  be  received  as  a  charge  to  the 
Good-will  account  and  offset  such  debit  by  a  credit  either 
to  the  Profit  and  Loss  account,  or  to  the  Capital  account 
or  accounts.  Following  this  entry,  the  procedure  will 
vary  as  above  indicated. 
2.  Settlement   for  take   over.     The   manner   of  booking  the 

settlement  separates  itself  along  the  following  lines: 

a.  Old  concern  considered  as  liquidated.  Hereunder,  the 
vendor's  books  will  be  closed  by  Journal  entries  debiting 
the  corporation  with  the  sum  of  all  the  assets,  crediting 
each  asset  account, — and  debiting  each  liability  account, 
inclusive  of  the  Capital  account  or  accounts,  and  credit- 
ing the  corporation. 

b.  Old  concern,  as  an  enterprise,  considered  as  accepting 
the  stock  in  payment  for  its  net  assets.  This  method 
will  show  the  settlement  upon  the  vendor's  books  by 
changing  the  last  entry  so  that  the  liabilities  outside  of 
the  Capital  accounts  will  be  charged,  and  the  corpora- 
tion credited;  that  a  Stock  account  will  be  charged  for 
the  amount  of  stock  received  from  the  corporation,  iand 
a  credit  to  the  corporation;  that  the  Capital  accounts 
will  be  charged,  and  the  Stock  account  credited. 


CORPORATIONS-ORGANIZATION;  RECORDS  167 

3.  Records  in  which  entries  are  made.    Briefly,  the  idea  here- 
under may  be  described  as  follows: 

a.  Old  books  of  account  used  by  the  corporation.  When  a 
sole  proprietorship  or  a  partnership  business  is  incorpo- 
rated, and  no  actual  transfer  of  assets  from  one  enter- 
prise to  the  other  is  contemplated,  the  old  books  of 
account  may  be  retained  and  only  certain  changes  be 
made  therein  necessitated  by  the  incorporation.  This 
method  of  handling  is  illustrated  by  the  solution  to  the 
problem  presented  at  the  end  of  the  present  section. 

b.  New  books  of  account  used  by  the  corporation.  The  use 
of  new  books  of  account  presents  nothing  of  difiiculty 
with  the  result  that  their  consideration  will  not  be  com- 
mented upon  except  in  connection  with  illustrative  prob- 
lems. In  fact,  the  solutions  to  the  problems  already 
used  were  made  from  the  point  of  view  of  new  books 
being  used. 

Problem.— The  following  simple  C.  P.  A.  problem  illustrates  the  changes 
required  in  the  old  records  when  the  business  of  a  sole  trader  is  incorpor- 
ated, no  assets  being  transferred  to  a  new  set  of  books. 

A.  J.  Andrews  has  conducted  a  retail  business  for  three  years.  His 
profits  have  been  $7,000.00  fpr  1913,  $8,000.00  for  1914,  and  $10,000.00 
for  1915  before  charging  any  salary  for  his  own  services.  To  obtain  the 
capital  needed  to  purchase  the  new  fixtures  necessary  in  a  new  store  which 
he  proposes  to  lease,  and  also  to  increase  his  stock  of  merchandise,  he 
decided  to  incorporate  on  December  31,  1915,  for  $50,000.00  and  to  seU 
part  of  the  capital  stock. 

C.  F.  Martin  agrees  to  purchase  $20,000.00  of  the  stock  at  par  and  to 
pay  for  it  inmiediately.  It  is  agreed,  also,  that  in  the  new  corporation 
Andrews  is  to  be  aUowed  credit  for  good-will  equal  to  the  sum  of  his  profits 
for  the  past  three  years  after  deducting  an  annual  salary  of  $4,000.00. 

Draft  the  Journal  entries  necessary  to  adapt  Andrews'  books  for  use  as 
the  books  of  the  corporation,  and  prepare  a  Balance  Sheet  showing  the 
condition  upon  completion. 

Andrews  presents  the  following  Ust  of  assets  and  habilities,  which  Martin 
accepts  as  correct: 

Assets:  Furniture  and  Fixtures,  book  value,  $6,000.00,  worth  $4,000.00 
Merchandise,  market  value,  $20,000.00,  cost  $18,000.00 
Accounts  Receivable,  book  value,  $6,500.00,  collectible,  $6,000.00 
Cash,  $400.00 

Liabilities:  Trade  Creditors,  $8,900.00 
Bank  Loans,  $1,500.00 


I 


f« 


ADVANCED  ACCOUNTING 


Solution. — The  first  step  is  to  book  the  good-will  item,  its  amount  being 
calculated  as  under: 
Profits: 

1913,  t  7,000.00 

1914,  8,000.00 

1915,  10,000.00 

Total, 
Three  years'  salary  @  $4,000.00 

•25,000.00 
12,000.00 

Good-will, 

$13,000.00 

The  entry  for  this  good-will  would  be: 
Grood-will, 
To — ^A.  J.  Andrews — Capital, 

$13,000.00 

$13,000  00 

Next,  the  corporate  stock  entries  may  be  recorded: 

Unissued  Capital  Stock, 
To — Capital  Stock  Authorized, 
To  record  authorized  issue. 
Subscribers  to  Capital  Stock, 

To — Subscriptions  to  Capital  stock. 
To  record  subscriptions  as  follows: 
C.  F.  Martin,                       $20 ,  000 .  00 
A.  J.  Andrews,                       30 ,  000 .  00 

$50,000.00 
$50,000.00 

$50,000  00 
$50,000  00 

Total                                 $50,000.00 

At  this  point  it  will  be  necessary  to  determine  how  dose  the  stock  taken 
by  Andrews  agrees  with  the  net  amount  in  his  Capital  account,  on  the 
valuation  basis  used: 

Furniture  and  fixtures,  booked  at                           $6 ,  000 .  00 
Less:  Reduction  agreed  upon,                               2,000.00    $  4,000  00 

Merchandise  (at  cost), 
Accounts  receivable, 

Less:  Bad  debts  (uncollectible), 

$6,500.00 
600.00 

18,000  00 
6,000  00 

Cash, 

400  00 

Total  Assets, 
Trade  creditors. 
Bank  loans, 

$8,900.00 
1,500.00 

$28,400.00 
10,400  00 

Net  Assets  Invested, 
Good-will  (entry  No.  1), 

$18,000  00 
13,000  (K) 

Net  Present  Balance  in  Capital  Account, 
Stock  taken  (see  subscription  entry). 

$31,000  00 
30,000  00 

Balance  to  Remain  in  Capital  Account, 

$  1,000.00 

Upon  the  basis  of  the  Ust  of  assets  and  liabihties  which  C.  F.  Martin 
agrees  to  accept  as  correct,  it  is  necessary  to  reduce  the  Capital  account 
of  A.  J.  Andrews  in  accord  therewith: 
A.  J.  Andrews — Capital,  $2,500.00 

To— Furniture  and  Fixtures,  $2 ,  000  00 

Accounts  Receivable,  500.00 


CORPORA  TI0N8—0RGANIZA  TION ;  RECORDS 


169 


When  C.  F.  Martin  pays  in  his  cash,  the  entry  will  be: 
Cash,  $20,000.00 

To— Subscribers  to  Capital  Stock,  $20 ,000 .  00 

Likewise,  when  A.  J.  Andrews  contribution  is  booked,  the  entry  to  cover 
is  as  under: 

A.  J.  Andrews— Capital,  $30 , 000 .  00 

To — Subscribers  to  Capital  Stock,  $30,000  00 

And  the  last  entry  necessary,  will  be: 
Subscriptions  to  Capital  Stock,  $50 ,  000 .  00 

To — Unissued  Capital  Stock,  $50 ,  000 .  00 

If  desired,  in  the  above  solution,  one  might  short  cut  the  entries  so  as  to 
eUminate  the  use  of  the  Subscription  and  Subscribers  accounts. 

The  final  step  in  the  solution  will  be  to  prepare  the  opening  Balance  Sheet 
of  the  corporation.    This  follows: 

RETAIL  CORPORATION 


BALANCE  SHEET 


as  at 


Assets 


Current  Assets: 
Cash 

Accounts  Receivable, 
Merchandise  (cost). 

Total  Current  Assets, 
Furniture  and  Fixtures, 

Good-will, 


Liabilities 
Current  Liabilities: 

Bank  Loans, 
Accounts  Payable, 
A.  J.  Andrews: 

Net  Assets  Invested, 

Good-will, 

Stock  Issued, 

Total  Current  Liabilities, 
Capital  Stock, 


$20,400.00 

6,000.00 

18,000.00 

$44,400  00 
4,000.00 

13,000.00 
$61,400.00 


1,500.00 
8,900.00 


$18,000.00 
13,000.00 

$31,000.00 
30,000.00 


1,000.00 

$11,400.00 
50,000.00 

$61,400.00 


Transfer  of  the  Business  of  a  Partnership  to  a  Corpora- 
tion.— To  illustrate  further  the  transfer  of  a  business  to  a  cor- 
poration and,  likewise,  to  show  the  closing  entries  necessary 
upon  the  books  of  the  vendor  concern,  the  following  simple  prob- 
lem and  solution  are  submitted: 


1 


|l 


!<■ 


I 


I 


170 


ADVANCED  ACCOUNTINO 


Problem. — Smith,  Jones  &  Company,  a  partnership  conducting  a  toy 
manufacturing  business,  and  sharing  profits  in  proportion  to  investments, 
decides  to  sell  out  to  the  Sterling  Toy  Company,  whi(;h  the  partners  have 
incorporated  with  an  authorized  capital  stock  of  $175,000.00,  all  of  which 
stock  is  to  be  issued  to  the  three  partners  in  exchange  for  their  respective 
interests  in  the  business  as  covered  below.  The  contract  of  sale  rc'fnrs 
only  to  the  fixed  assets  and  to  the  working  and  tra<ling  assets,  since  the 
partnership  has  agreed  to  liquidate  its  own  liabilities.  The  following  Bal- 
ance Sheet  was  prepared  as  of  September  30,  1921,  on  the  basis  of  which 
the  corporation  is  to  succeed  to  the  business  as  of  October  1,  1921: 


11.000.00 

7,000.00 

40,000.00 

6,000.00 

20,000.00 

25,000.00 

4,000.00 

6, .500. 00 

40,000.00 

46,700.00 


$  10,000.00 

45,000  00 

1,200  00 

60,000  00 

60,000  00 

30,000  00 

$206,200.00  $206,200  00 


Cash, 

Notes  Receivable, 

Accounts  Receivable, 

Finished  Goods, 

Goods  in  Process, 

Materials  and  Supplies, 

Furniture  and  Fixtures, 

Small  Tools, 

Machinery  and  Equipment, 

Land  and  Building, 

Notes  Payable, 

Accounts  Payable, 

Wages  Accrued, 

Smith — Capital, 

Jones — Capital, 

Edgar — Capital, 

Required: 

1.  Closing  entries  for  the  partnership 

2.  Opening  entries  for  the  corporation 

Solution. — The  entries  required  to  close  the  partnership  books  are  as 
follows: 

(1) 
Good-will, 
To — Smith — Capital, 
Jones — Capital, 
Edgar — Capital, 
To  raise  the  value  of  the  good-will  of 
the  partnership  at  the  time  of  its 
sale  to  the  Sterling  Toy  Company, 
and  to  distribute  same  to  the  part- 
ners in  proportions  to  which  they 
are  entitled. 

(2) 
The  Sterling  Toy  Company, 
To — Good-will, 

Land  and  Building, 


$  26,800.00 


$  10,720  00 

10,720,00 

5,360  00 


$175,000.00 


$  26,800  00 
46,700  00 


CORPORATIONS— ORGANIZA TION ;  RECORDS 


171 


Machinery  and  Equipment, 

Small  Tools, 

Furniture  and  Fixtures, 

Materials  and  Supplies, 

Goods  in  Process, 

Finished  Goods, 

To  close,  to  the  debit  of  the  vendee 

company,  the  assets  sold  thereto, 

as  per  bill  of  sale  on  file. 

(3) 
Cash, 

To — Notes  Receivable, 

Accounts  Receivable, 

To  record  collection  of  above  assets. 

(4) 
Notes  Payable, 
Accounts  Payable 
Wages  Accrued, 
To— Cash, 

To  record  settlement  of  above  lia- 
bilities. 

(5) 
Capital  Stock  (The  Sterling  Toy  Company), 
To — The  Sterling  Toy  Company, 

To  bring  onto  the  books  the  1,750 
shares  of  stock  received  from  the 
Sterling  Toy  Company  in  ex- 
change for  the  business  of  the 
partnership. 

(6) 
Smith — Capital, 
Jones — Capital, 
Edgar — Capital, 

To— Capital  Stock  (The  Sterling  Toy  Com- 
pany), 
Cash, 

To  close  the  capital  accounts  of  the 
partners,  thus  closing  all  the  ac- 
counts on  the  partnership  books, 
they  having  received  stock  from 
the  vendee  corporation,  and  cash, 
as  their  interests  may  appear,  as 
follows: 

Stock 

$  70,000.00 
70,000.00 
35,000.00 


Smith, 
Jones, 
Edgar, 

Total, 


$  47,000.00 


$  10,000.00 

45,000.00 

1,200.00 


$175,000.00 


$  70,720.00 
70,720.00 
35,360.00 


Cash 

$  720.00 
720.00 
360.00 


40,000.00 

6,500.00 

4,000.00 

25,000.00 

20,000.00 

6,000.00 


$     7,000.00 
40,000.00 


$  56,200.00 


$175,000.00 


$175,000.00 
1,800.00 


Total 

$70,720.00 
70,720.00 
35,360.00 


$175,000.00   $1,800.00   $176,800.00 


172 


ADVANCED  ACCOUNTING 


The  entries  to  open  the  corporation  books  are  as  follows: 

(1) 
Pro-Forma  Entry 

The  Sterling  Toy  Company,  A  Corporation 

Incorporated  Under  the  Laws  of  the  State  of 


With  an  Authorized  Capital  of 

One  Hundred  Seventy-Five  Thousand  Dollars  ($175,000.00) 

Divided  into 

Seventeen  Hundred  and  Fifty  Shares  ( 1 ,750) 

of  the  Par  Value  of 

One  Hundred  Dollars  ($100.00)  per  Share 

With  Express  and  Implied  Power  to  Conduct 
A  Manufacturing  Business 


(2) 

Plant  and  Sundry  Assets, 

To — Smith,  Jones  &  Company,  Vendors, 

To  record  purchase  of  the  following 
assets,  as  per  bill  of  sale  on  file* 
Fixed  Assets: 
Land  and  Build- 
ing, 
Machinery  and 

Equipment, 
Small  Tools, 
Furniture  and 
Fixtures, 


$175,000.00 


$175,000  00 


$  46,700.00 

40,000.00 
6,500.00 


4,00000 
$  97,200.00 


< 


Working  and  Trading  Assets: 
Materials  and 

Supplies, 
Goods  in  Process, 
Finished  Goods, 


$  25,000.00 

20,000.00 

6,000.00 


I 


$  51,000.00 
Total  Assets,  $148,200.00 

The  values  shown  above  are  as 
they  appear  upon  the  Balance 
Sheet  of  the  vendor  firm;  the 
account  of  Plant  and  Sundry 
Assets  will  remain  open  as 
above  shown  until  the  passage 
of  a  resolution  by  the  Board  of 
Directors    valuing    the    assets, 


CORPORATIONS-ORGANIZATION;  RECORDS  173 

and  at  the  same  time  stating 
the  nature  of  the  excess  pur- 
chase price  over  the  book  value. 


$175,000.00 


$175,000.00 


Smith,  Jones  &  Company,  Vendors, 
To — Capital  Stock, 

To  record  settlement   of  purchase 
price 

No  Par  Value  Capital  Stock.— Certain  states,  among  them 
New  York,  permit  corporations  to  organize  with  shares  of  stock 
of  no  specified  par  value.  Considerable  may  be  said  in  favor 
of  issuing  such  stock,  and  it  is  believed  that  in  the  course  of 
time  nearly  all  corporations  will  be  organized  under  this  princi- 
ple. Each  share  of  stock  represents  an  aliquot  part  or  interest 
in  the  corporate  assets,  the  value  of  each  such  share  being  de- 
pendent upon  the  actual  value  of  the  assets  rather  than  upon 
some  fictitious  or  visionary  value;  in  ordinary  stock,  the  par 
value  necessarily  has  no  relation  whatever  to  actual  value,  the 
par  value  being  merely  an  arbitrary  amount  which  often 
proves  to  be  an  easy  medium  for  carrying  out  fraudulent 
schemes. 

The  accounting  for  this  class  of  stock  really  is  a  simple  matter. 
Basically,  there  is  no  need  of  doing  otherwise  than  to  provide  for 
showing  in  the  Capital  Stock  account  the  exact  value  or  selling 
price  of  the  stock  at  the  time  of  issuance.  No  Unissued  Capital 
Stock  account,  and  no  accounts  with  premiums  or  discounts 
need  be  used. 

The  Capital  Stock  account  should  reflect  the  value  of  whatever 
the  no  par  value  stock  was  issued  for,— whether  for  cash,  prop- 
erty, or  services.  Next,  if  any  change  should  take  place  in  such 
values  during  any  period  of  time,  the  fluctuations  thereof  should 
be  absorbed  and  be  indicated  in  the  proper  reserve  accounts  and 
in  the  Surplus  account;  the  Surplus  account,  in  other  words,  at 
all  times  should  record  undistributed  net  earnings. 

In  using  this  class  of  stock,  no  need  exists  for  using  a  Surplus 
account  to  represent  paid  in  surplus,  which  so  often  is  made  use 
of  when  par  value  stock  is  the  class  used.  The  effect  of  dis- 
posing of  shares  at  different  values  is  merely  to  raise  or  lower 
the  value  of  each  unit  or  share  already  outstanding  so  that  all 
are  on  a  parity.    By  such  act,  each  share  represents  a  definite 


174 


ADVANCED  ACCOUNTING 


'i> 


in 


!l 


portion  or  aliquot  part  of  the  entire  capital  excluding,  however, 
whatever  amount  of  capital  may  be  allocated  to  some  other  class 
of  stock  due  to  the  existence  of  some  preference  in  relation 
thereto. 

But  it  should  be  recognized  at  present,  in  connection  with  plac- 
ing a  value  upon  no  par  value  stock  that,  where  legally  possible, 
an  expedient  is  used  of  placing  a  value  thereon  which  in  amount 
is  less  than  the  value  received  therefor.  In  New  York,  for  ex- 
ample, this  stock  cannot  be  issued  for  less  than  $5.00  a  share, 
and  the  capital  value  as  stated  in  the  articles  of  incorporation 
is  the  minimum  below  which  such  value  cannot  be  reduced,  as 
by  dividend  payments.  Hence,  by  taking  advantage  of  the  law, 
a  $5.00  value  often  is  placed  upon  each  share  regardless  of  what 
actually  was  received,  so  that  dividends  may  l>e  paid  out  of  capi- 
tal if  the  desire  exists  to  do  so. 

The  difference  between  the  amount  of  capital  paid  in  and 
the  small  arbitrary  value  booked  against  the  no  par  value  capi- 
tal stock  will  be  carried  as  a  special  surplus,  say.  Capital  Sur- 
plus. However,  it  would  seem  that  if  no  par  value  capital 
stock  is  booked  at  the  original  value  placed  thereon,  as  is  capital 
stock  having  a  par  value,  which  may  be  done,  the  one  Surplus 
account  would  be  sufficient  even  though  both  kinds  of  stock  are 
in  existence.  As  concerns  the  surplus,  no  real  difference  would 
seem  to  exist  between  par  value  stock  and  no  par  value  stock. 

Donated  treasury  stock  will  b^  a  rarity  in  that  no  reasonable 
object  will  be  secured  by  any  act  of  donation.  The  donation  of 
par  value  stock  too  often  represents  merely  an  expedient  to  get 
around  the  legal  requirement  that  stock  shall  not  be  issued  at 
a  discount;  the  use  of  no  par  value  stock  was  designed,  from 
one  point  of  view,  to  prevent  such  a  practice.  If,  however,  o(;ca- 
sion  should  arise  under  which  such  stock  was  donated  to  the 
treasury,  the  donation  may  be  booked  in  the  Treasury  Stock 
account  by  number  of  shares  only,  and  no  par  value  be  shown 
therefor;  the  number  of  shares  so  carried  then  would  be  deducted 
from  the  total  shown  as  issued  in  the  Capital  Stock  account,  so 
that,  on  the  Balance  Sheet,  there  would  be  shown  the  actual 
number  issued  and  outstanding.  If,  however,  the  company  pur- 
chased some  of  this  stock  and  placed  it  in  the  treasury,  the  Tnjas- 
ury  Stock  account  should   show  the  purchase  cost  thereof  as 


mmKATioKs-oaoAmATrnx,  stcom       m 

....  j-ieS  tit  zz^^j^:-^ 

each.     Likewise,  thek  are  to  be ^^S.^       ?  ""^  "'''"*  "'  »'"'•«> 
Havin,  no  pa.  value.     P^^entX ^^.^^  trLTZ:,  "^  ^'^ 

heading  shouId^eferrthetctXtSH'^"*  %'"''''"'  "'  *•>«  ^°™^ 
with  no  par  value"  have  been  authl>.T  ^"^  °!  "°'°°""'  "''PiW  «tock 

hereunder  already  has  be^^hr^^^vtu^t"!:  'ITT'  '""^  ^'^'^ 
problem,  it  is  omitted  here.  Previously  m  connection  with  another 

When  the  preferred  stock  ii  snW   ti.. 
Likewise,  when  some  of  the  no  par  ^h,!  """^^  '"'"''  «•«'"'<•  ^  looked, 
entry  is  necessary,  about  as  f^Iows:  "^°°  '*"'*'''  '"^'^  '«  «"<»■  an 

Subscribers  (or  Cash) 

To— Capital  Stock— Common  *  ^ 

And  this  common  stook  ahm.M  k_  .   .  *  ^ 

atock  was  issued  ^be  shown  wTe:;;l:V°  *'"'*  *""  ^""^  '''  -"ch  the 
Also,  since  the  account  with  Cartel  S^rckV'^'*'*^'  "'"''•  »'  ^^<=^- 
number  of  shares  outstanding  a  notafi^„r^,Tr"  '^"  ''°*  ''^"='  *•>« 
itself  of  the  number  of  shaZlJnT  ^  """^^  '"  ***«  """""n* 

porations  may  be  claLdTs  ^°''''  '"  «'°^^^^'  '"^'^  '-^- 

1.  Those  with  a  small  capital  stock. 

2.  Those  with  a  large  capital  stock. 

latter  comprise  IZ  i:^^^!^:^' ^  T'-''  ''^ 
.s  scattered  widely,  and  the  shar  s  oT  which  are  ht  7^ ''^ 
the  various  stock  exchanges  handled  upon 

wHeh\rrhesre^:ndrr  -tt'^''---^  '^-^- 

the  benefits  of  a  corS.  "l^'"^  ^'  ^''^''  *»  attach 

but  still  retain  th  X "  eoSr**«°  ^''  ''^'^^  "ability), 
Will  commonly  ^r  "  cornorlTi  ^7°'"'^'^  "'  '°*^'««t-  ^e 
will  consist  of  hilel?  ITcertaTn  *l^*°'='^'^°'d-  of  which 
associates.  Such  a  company  is  S  "'  °'"  '^"'^  business 

tion  met  with  in  acZ'ng  w^rk."""""  *"'"  ''  '''''  ''°'^- 


I  ui 


176 


ADVANCED  ACCOUNTINO 


f 


In  a  close  corporation,  a  stockholder  who  does  not  own  or  con- 
trol a  majority  of  the  shares  of  capital  stock  is  always  at  a 
disadvantage.  Those  in  control  can  elect  a  management  subser- 
vient to  their  mandates  and,  by  so  doing,  keep  the  minority 
stockholders  from  any  active  connection  with  the  company; 
likewise,  they  may  refuse  to  declare  dividends  on  the  ground  that 
the  earnings  must  be  put  back  into  developing  the  enterprise. 
Again,  by  voting  large  salaries  to  the  corporate  officers,  they 
may  show  a  deficit  at  the  end  of  the  year  rather  than  a  profit 
out  of  which  dividends  can  be  declared. 

By  keeping  the  minority  stockholders  ignorant  of  the  actual 
condition  of  affairs,  and  by  depriving  them  in  divers  ways  of 
sharing  in  the  management  of  the  company,  and  of  securing  a 
periodical  return  upon  the  investment  made,  those  in  control 
may  so  discourage  the  minority  that  the  latter  may  attempt 
to  dispose  of  their  holdings.  And  since  these  conditions  tend  to 
create  a  limited  market  in  which  such  holdings  may  be  disposed 
of  profitably,  such  a  disposal  may  prove  to  be  impossible  or, 
if  possible,  only  at  a  marked  sacrifice.  Therefore,  although  the 
close  corporation  idea  may  appeal  to  one  who  desires  to  control 
corporate  affairs,  the  one  who  expects  only  to  have  a  minority 
interest  therein  should  be  extremely  careful  before  making  his 

investment.     If  the  controlling  interest  does  not  play  fair, 

though  not  guilty  of  actual  fraud  or  gross  mismanagement,  the 
minority  shareholder,  even  without  wanting  to  have  anything 
to  do  in  the  management  of  the  company,  may  be  so  "man- 
handled" that  his  investment  will,  at  best,  be  a  decidedly  ques- 
tionable one. 

To  get  around  this  possibility  of  not  interesting  a  possible 
minority  shareholder  in  a  contemplated  corporate  enterprise,  the 
incorporators  may  decide  to  place  on  the  market  more  than 
one  class  of  stock,  as  preferred  and  common.  Since  the  preferred 
stockholder,  ordinarily,  is  assured  of  his  dividend,  he  may  de- 
cide to  come  in.  Again,  the  hesitancy  may  be  removed  by 
providing  for  cumulative  voting;  this  has  been  discussed  above. 

The  large  industrial  and  public  utility  companies  are  found 
in  the  second  class.  Their  capital  stock  is  divided  into  a  great 
number  of  shares  and  the  stockholders  are  continually  changing. 
The  stocks  of  these  companies  are  dealt  in  upon  the  various 


COMPOEATIONS^ORGANIZATION;  RECORDS  177 

SlteSe'^''   ""'^^   ^^'^"^^    -"^^^-^^   they    are    readily 

remain  in  control  only  so  Z^^.f^^^      ^^1  management  will 
the  management  becom:s  S^^^^^^  ^«  --  as 

the  annual  meeting,  either  Tnn^^^^^^  the  stockholder,  voting  at 

it  may  on  the  surfL  appear  ^lil^.""!  '"^;  ^^^^  ^^^^^ 
of  stock  held,  was  insiS     I  ''^''  ^'''  ^^^  ^^^^  share 

possible  of  b  ing  ear^av  h^^^  -  compared  to  all  the  votes 
Ordinarily,  at    '.TC7o^\^n  t      '^^  ^"^^^^"*  '''^^' 


tfSI 


CHAPTER  VI 

INVESTMENTS:  STOCKS,  BONDS  AND 

MORTGAGES 

Introduction. — The  major  topic  of  the  present  chapter  relates 
to  certain  accounting  principles  which  an  investor,  indi^'idual 
or  company,  should  find  of  value.  Investment  accounting;  and 
the  accountancy  of  investment  are  not  one  and  the  same.  The 
latter  is  a  term  of  much  narrower  and  technical  significance 
than  the  former  and  is  but  slightly  made  use  of  herein  in  that 
this  is  not  assumed  to  be  a  text  upon  mathematics. 

Investments  in  General. — At  this  moment,  the  bookkeeping 
necessary  for  the  investment  of  a  sole  trader  in  his  business, 
for  the  investments  of  partners  in  a  firm,  and  for  stockholders 
in  a  corporation,  should  be  familiar  to  the  student,  in  that  the 
procedure  in  relation  thereto  often  is  referred  to  as  contemplat- 
ing the  opening  entries.  This  angle  of  the  subject  is  of  no  con- 
cern in  the  present  chapter  except,  perhaps,  by  way  of  compari- 
son. 

Profit  is  the  general  object  for  which  a  business  organization 
functions,  regardless  of  its  particular  line.  And  to  carr>^  out 
an  undertaking,  capital  is  necessary  which,  in  amount,  should 
be  adequate.  The  form  of  this  capital  will  \'ary,  comprising  the 
assets  necessary  for  the  purposes  in  mind.  In  the  original  in- 
stance, some  will  be  land,  some  buildings,  some  equipment,  and 
some  cash;  later,  there  usually  will  be,  also,  notes  and  accounts 
receivable,  as  well  as  materials  and  supplies  and  merchandise. 

As  to  each  one  of  these  items,  the  capital  therein  invested 
should  be  proportionate  to  needs.  Cash  should  not  be  tied  up  to 
the  end  that  current  liabilities  cannot  readily  be  liquidated.  If 
profits  be  made,  it  is  presumed  they  will  be  converted  into  cash 
so  that  dividends  may  be  paid.  If  the  profits  accumulated  or 
acquired  exceed  a  fair  dividend  return  on  inxested  capital,  a  sur- 
plus is  created,  consisting  of  undivided  profits.     Finally,'  if  the 

178 


mVESTMmrS:  STOCKS,  BONDS  AND  MORTGAGES      179 
fund  of  cash  on  hand  grows  hpvnnri  +i.« 
purposes  and  dividends^  excLs  carrvT"'^  °'  ^™* 

different  forms  of  assets  known  !  La'  J  a^'ln      T""  w,'  "'^ 
These  invp<!fm»nfc   f  "  generally  as    Investments." 

into  t::  ;nic;;:;r'"^"  -^  '^'--^-'  -^  ^  divided 

1.  Investments  other  than  securities, 
a.  Goods  and  commodities. 

2  SecuritLr''*'  '"^''*"'"*^--''»>d  "r  buildings. 

a.  Stock. 

b.  Bonds. 

.!•  Conditional-bond  and  mortgage. 
II.  Single— usual  corporate  bonds 

ExcMng  item  1.    ,CvI    ™?        ""!''  °'""'»"  I'"n«~.. 

At  best,  they  are  temporary  in  charart.Pr      «• 
been  discussed  fully  in  coMertinn  „  /!*'f  *^'-     ^'^ce  they  have 
counting,  and  invofve  nothS  ^.^     "'^"'^''^^^  Phases  of  ac- 
tional cj;cussionir:iitt^  ^""'^ ""'  ~^'>*'  ^^'^*- 

2.  Land  or  buildings,  collectively  known  as  real  estate     Th 
investments  arise  in  one  of  two  ways  •  ^^ 

a.  By  direct  purchase 


180 


ADVANCED  ACCOUNTING 


III 


( 


i 


brances,  and  the  vendor  should  see  to  this  before  the  sale 
is  consummated.  But  in  the  absence  of  fraud  on  the 
part  of  the  seller,  the  covenants  of  the  deed  of  sale  regu- 
late the  rights  and  liabilities  as  between  vendor  and 
vendee.  A  purchase  may  be  made  subject  to  certain 
incumbrances,  which  latter  include  such  items  as:  mort- 
gages, mortgage  interest,  taxes,  assessments,  mechanics' 
and  landlords'  liens,  judgments,  attachments,  pending 
litigation,  etc.;  some  of  these  to  be  binding  upon  third 
persons  must  be  recorded  and  others  will  not  entail  this 
requirement.  The  prospective  purchaser  should  ascer- 
tain what  the  incumbrances  are,  if  any ;  ignorance  there- 
of is  no  defense  should  a  controversy  arise  later  thereon. 
Certain  of  the  variations  encountered  in  relation  to  the  al)ove 
may  be  summarized  about  as  follows: 

1.  The  buyer  may  purchase  ex  all  incumberances.  Here  the 
vendor  must  take  care  of  them. 

2.  The  buyer  may  assume  all  lien  liabilities. 

In  any  given  case,  the  statutes  must  be  consulted  carefully  to 
determine  whether  (1)  or  (2)  above  may  be  carried  out  in  its 
entirety.  For  example,  the  owner  as  of  a  day  certain  may  be 
held  liable,  in  some  states,  for  the  year's  taxes.  A  vendor's 
creditor  cannot  look  to  the  vendee  for  payment  unless  the  latter 
has  bound  himself  by  written  agreement  to  make  such  payment. 

Accounting  for  Real  Estate  Investments.— The  procedure 
hereunder  follows  a  two-way  possibility: 

1.  If  purchaser  assumes  existing  liens.  His  books  should 
show  a  purchase  value  consisting  of  two  elements: 

a.  Cash  paid. 

b.  Liabilities  assumed. 

i.  Existing  liens  assumed, 
ii.  Purchase  money  mortgage. 

2.  If  the  purchaser  does  not  assume  existing  liens,  but  leaves 
the  vendor  to  take  care  of  them.  His  books  should  show 
a  purchase  value  consisting  of  either  one  or  two  elements: 

a.  Cash,  or 

b.  Cash  plus  a  purchase  money  mortgage. 

Property  may  be  acquired  in  either  of  two  ways,  and  tlie  cost 
thereof,  as  to  elements  included,  is  dependent  thereon: 


INVESTMENTS:  STOCKS.  BONDS  AND  MORTGAGES      m 

1.  By  purchase  in  the  open  market.    This  point  should  have 

rt^irrnTw^"'""^  '"  ''''  studentfearlier  work  ^ 
require  no  further  comment  at  this  time. 

2.  By  result  of   foreclosure  proceedings.     This  would   per- 

Zl^L  ''^''  *°  mortgagor,  and  amounts  paid  out 

for  taxes    msurance,  repairs,  and  improvements  prior  to 
default  of  mortgagor.  ^         ^ 

thtnc^t\fT^'"'  may  be  booked  at  market  values  rather 
SdTcallv    bv  ^IT    ''  ''•""  fluctuations  must  be  adjusted 
creditmg  or  debitmg  the  Profit  and  Loss  account 
Investment  items  may  be  carried  upon  the  General  Ledger  in 

are  oT  mo^nh  ""''  ^"*"^"*^-  ^^^■"'  "  '^^  --tl " 
are  of  more  than  one  class,  separate  accounts  may  be  carried 
upon  the  General  Ledger  for  each  such  class.  Again  Vspec Sv 
m  large  organizations,  the  investments  may  be  sXTentv 
numerous  to  warrant  the  use  of  subsidiary  records  eSh  su  h 
controlled  upon  the  General  Ledger  by  the  nroDer  cnntJv 
account;  and  each  such  snM,iJ rjJZmZZTl 
the  mformation  worth-while  pertaining  to  the  assete     ilit 

p::SyT:srb^"";^r°"•"'^'"^ 

property,  ,t  might  be  highly  desirable  to  give  each  such  niece  a 
separate  account  upon  a  subsidiary  Ledger  controlled  u,^n  the 
General  Ledger  in  the  usual  way.    A  special  form  o^^dger 

^ould  provide  space  for  a  number  of  notations  concerning  the 
property  therein  booked,  as:  name,  location,  date  acou^S  and 
how  acquired.  The  body  of  each  account  may  be  Sed'  int^ 
three  major  portions:  investment,  incumbrances,  and  ilme^ 
and  each  such  section  would  be  columned  to  show  da  e  d^' 
ticulars,  debits,  credits,  and  balance  '  ^ 

nav  T*!.  ^i""*^-^  ^°d  •«  a  'bitten  promise  under  seal  to 
pay  a  definite  sum  of  money  at  a  stated  future  time     It  is 

estate  held  by  the  issuing  company.    Likewise,  an  agreement 
exists  to  pay  interest  at  certain  periods. 

Bonds  are  issued  in  varying  denominations,  110000  S^iOnm 
$1,000.00,  $5,000.00,  $10,000.00,  and  at  times  e;en  iai^e'r.    W 


,i 


Ill 


It 


182 


ADVANCED  ACCOUNTING 


times,  for  popular  subscription,  bonds  are  issued  at  a  face  value 
less  than  $100.00.  In  no  way  does  a  bond  partake  of  the  nature 
of  stock.  A  bond  is  a  direct  corporate  obligation  which  may  or 
may  not  be  given  certain  other  rights  incidental  to  those  usually 
accorded  a  bond,  as: 

1.  Right  to  participation  in  corporate  prol&ts. 

2.  Voting  rights,  unless  the  statutes  forbid. 
Classification  of  Bonds. — A  corporation  has  its  choice  of 

issuing  any  one  of  a  number  of  various  kinds  of  bonds.  It  is 
impossible  herein  to  discuss  thoroughly  each  and  every  kind; 
a  book  on  corporate  finance  should  be  studied  in  this  connection. 
All  bonds  may  be  classified  under  four  possible  headings  and. 
when  considering  the  name  of  a  specific  bond,  care  should  l>e 
taken  to  allocate  properly  such  name  against  the  correct  head- 
ing so  that  such  title  may  be  the  better  understood.  On  the  basis 
of  a  representative  list  of  bonds  this  four-way  classification  may 
be  as  follows: 

1.  As  to  manner  of  payment: 

a.  Coupon  bonds. 

b.  Registered  bonds. 

i.  Registered  as  to  principal  only, 
ii.  Registered  as  to  both  principal  and  interest. 

2.  As  to  security: 

a.  Mortgage  bonds. 

b.  Car  or  equipment  trust  certificates. 

c.  Collateral  trust  bonds. 

d.  Prior  lien  bonds. 

e.  Debenture  bonds. 

f.  Income  bonds. 

g.  Receivers'  certificates. 

h.  Bottomry  and  respondentia  bonds. 

3.  As  to  purposes: 

a.  Refunding  bonds. 

b.  Consolidated  bonds. 

c.  Adjustment  bonds. 

4.  As  to  conditions  of  redemption: 

a.  Gold  bonds. 

b.  Convertible  bonds. 


INVESTMENTS:  STOCKS,  BONDS  AND  MORTGAGES      183 

Upon  inspection,  it  will  be  noticed  that  the  above  grouping 
depends  upon  a  number  of  things,  as: 

1.  Nature  of  security. 

2.  Purpose  of  issue. 

3.  Conditions  of  payment  of  interest  and  principal. 

From  the  standpoint  of  an  accountant,  the  distinction  between 
registered  and  coupon  bonds  must  be  understood  clearly  There- 
fore, a  considerable  discussion  of  each  of  these  types  is  shown 
below.  Certain  of  the  other  types  are  discussed  in  a  brief 
manner  merely  to  give  the  student  an  inkling  of  the  variations 
encountered  in  bond  issues;  the  details  concerning  them  are  of 
considerably  more  interest  to  an  investor  than  to  an  accountant 

Bond  and  Mortgage.— Another  bond  classification  is  to 
classify  bonds  as  follows: 

1.  Single.  This  is  one  under  which  the  obligor  agrees  to  pay 
a  certain  sum  of  money  to  some  one  at  a  determinable 
future  date.     The  usual  corporate  bonds  are  of  this  type 

2.  Conditional.    This  is  one  under  which  the  obligation  be- 
comes void  when  the  obligor  performs  some  act  which 
otherwise,  would  remain  in  force.     The  simplest  way  to' 
secure  a  debt  by  mortgage  is  to  pledge  property  to  secure 
the  payment  of  a  promissory  note,  which  has  been  made  out 
m  due  and  usual  form.     A  mortgage,  representing  a  condi- 
tional transfer  of  certain  property,  as  real  estate,  is  made 
out  m  favor  of  the  payee  named  in  the  note  who,  in  case 
the  maker  of  the  note  does  not  fulfill  the  obligations  he  has 
undertaken,  will  commence  proceedings  to  have  the  prop- 
erty sold  m  accord  with  both  the  statutes  and  the  terms  of 
the  mortgage  to  the  end  that  the  proceeds  from  such  sale 
may  be  applied  toward  the  payment  of  the  principal  and 
interest  due  upon  the  note ;  any  residual  sales  amount  will  be 
turned  over  to  the  former  owner  of  the  property  covered  by 
the  pledge.    In  New  York,  and  in  some  other  states,  espe- 
cially  as  concerns  real  estate  loans,  it  is  customary  to  use  a 
bond  and  mortgage  rather  than  a  mere  note  secured  by  a 
mortgage;  such  a  bond  may  be  classified  as  "conditional"  in 
contradistinction  to  "single".    The  amount  of  the  bond  as  a 
rule,  is  for  a  sum  twice  the  size  of  the  principal  sum  to  be 
paid.    Formerly,  the  full  amount  of  the  bond  could  be 


V 


I 


II 


<  I 


184 


ADVANCED  ACCOUNTING 


collected,  but  now,  at  least  in  New  York,  nothing  can  be 
collected   beyond  the   actual   amount  due   for  principal, 
interest,  and  costs,  in  case  the  obligor   fails  to  meet  his 
obligation.     The  property  which  is  security  for  the  bond 
will  be  sold  subject  to  provisions  as  indicated  already  above. 
Naturally,  this  method  of  raising  money  is  of  limited  appli- 
cation; where  money  must  be  raised  from  a  number  (»f 
creditors,  to  be  held  for  a  number  of  years,  it  is  unsatis- 
factory in  that  provisions  are  not  made  to  make  trading 
and  transfer  convenient.    Hence,  the  form  of  bond  obliga- 
tion, already  considered,  is  preferable. 
Loans  secured  by  bonds  and  mortgages  require  no  difficult 
accounting,  but  provision  should  be  made  to  cover  all  the  possi- 
bilities that  may  arise.    As  will  be  noticed  later,  in  connection 
with  the  usual  types  of  bonds,  no  question  arises  here  as  to  par, 
premium,  and  discount.     The  records  should  show:  date  of  the 
bond,  date  of  maturity,  amount  or  face  of  the  bond,  interest  rate, 
and  dates  on  which  interest  is  payable. 

If  a  person  classifies  securities  as:  (1)  stocks,  and  (2)  bonds, 
a  short  term  note  must  be  considered  as  a  bond.  Then,  like- 
wise, it  would  seem  in  order  to  consider  a  note  secured'  by  a 
mortgage  as  a  bond.  The  ordinary  term  of  Mortgages  Receiv* 
able,  therefore,  would  fall  within  the  present  grouping. 

Where  a  mortgage  is  taken  as  security  for  a  loan,  great  care 
must  be  observed  in  keeping  a  complete  detail  record  thereof; 
a  subsidiary  Ledger  may  be  necessary  therefor,  if  transactions 
are  numerous.  And  therein,  for  each  mortgage,  the  following 
points  should  be  known  and  set  out:  name  of  mortgagor,  amount 
of  loan,  date  mortgage  given,  loan  maturity  date,  location  and 
general  description  of  property  mortgaged,  state  and  county, 
book  and  page  in  which  mortgage  recorded,  interest  rate,  interest 
dates,  fire  insurance  carried  on  buildings— number  of  policy, 
term  amount,  and  date  of  expiration,  insurance  company,  name 
of  person  paying  premium;  appraised  land  values  and  building 
values;  amount  of  instalment  payments  on  loan  principal: 
amount  of  interest  accrued,  due  and  paid.  Such  a  loan  should 
not  be  made  for  more  than  80  per  cent  of  the  appraised  value 
of  the  pledged  property;  generally,  it  will  be  less.  Interest 
accrues  from  the  date  on  which  the  money  is  paid  over  to  the 


INVESTMENTS:  STOCKS,  BONDS  AND  MORTGAGES      185 

mortgagor,  and  will  be  at  the  legal  rate  if  no  other  rate  is 
mentioned. 

Registered  Bonds.— Registered  bonds  have  a  certain  dis- 
tmctive  feature  in  that  their  number,  denomination,  payee, 
payee's  address,  etc.,  are  registered  in  the  name  of  the  payee  on 
the  books  in  the  office  of  the  issuing  corporation.  Transfer  of 
ownership  can  be  made  only  by  executing  a  power  of  attorney 
upon  the  back  of  the  bond  or  bonds  in  question  and  by  entry  of 
such  transfer  upon  the  Bond  Register  in  the  office  of  the  issuing 
company. 

The  owner  of  a  registered  bond  is  secure  in  his  possession  since 
title  does  not  pass  to  the  holder;  he  does  not  have  to  remember 
even  the  interest  periods,  and  he  runs  no  chance  of  loss  due  to 
losing  coupons.  Even  should  he  lose  the  bond,  or  should  it  be 
destroyed,  the  registered  owner  may  secure  a  new  one  by  proving 
his  loss,  and  by  giving  the  issuing  corporation  a  bond  to  indem- 
nify it  in  case  a  bona  fide  holder  of  the  supposed  lost  bond  puts 
in  an  appearance  and  holds  the  company  to  the  terms  of  their 
agreement.  The  cost  of  giving  such  a  bond  of  indemnity  is 
slight. 

Registered  bonds  are  printed  with  stubs  and  are  bound  to- 
gether in  a  manner  similar  to  that  of  a  Check  Book  or  Stock 
Certificate  Book.  When  a  bond  is  issued,  the  stub  is  filled  out 
with  the  name  of  the  payee,  etc.  An  account  is  opened  with 
each  bond  holder  in  a  Bond  Ledger  or  Register  and  information 
is  entered  therein  as  suggested  in  the  beginning  of  the  present 
section. 

When  a  transfer  is  made,  the  old  bond  is  cancelled  and  pasted 
back  on  its  stub  from  which  first  detached.  Then  an  entry  is 
made  in  the  account  of  the  surrendering  holder,  and  one  in  the 
account  of  the  new  bond  holder.  If  the  issue  is  large,  and  the 
transfers  many,  it  is  customary  to  make  use  of  a  Transfer 
Journal  to  expedite  the  labor  involved  in  making  transfers. 

So  far  as  the  general  books  are  concerned  the  issuing  com- 
pany merely  has  to  debit  the  Cash  account  for  proceeds  received 
and  credit  a  Bond  account  headed  to  indicate  the  particular  issue 
involved. 

When  interest  falls  due  on  these  bonds,  checks  therefor  are 
mailed  to  the  persons  whose  names  and  addresses  appear  upon 


(■ 


186 


ADVANCED  ACCOUNTING 


the  Bond  Register  as  of  the  date  upon  which  the  books  are 
closed  against  further  transfers. 

When  interest  is  paid,  which  must  be  done  periodically,  the 
issuing  company  first  will  prepare  a  list  of  the  bondholders  from 
the  Bond  Ledger,  and  the  amount  of  interest  each  is  to  receive. 
The  total  thereof  is  then  proved  against  the  bonds  outstanding 
as  shown  on  the  General  Ledger.  Subsequently,  the  checks  are 
drawn  in  favor  of  the  persons  whose  names  and  addresses  appear 
upon  the  Bond  Register, — those  whose  names  are  shown  upon 
the  interest  list. 

Coupon  Bonds. — Coupon  bonds  are  negotiable  instruments, 
title  passing  to  bearer  by  delivery,  having  a  number  of  interest 
coupons  (promissory  notes  or  contracts  payable  to  bearer) 
attached  to  them,  one  such  coupon  being  payable  quarterly, 
semi-annually,  or  annually,  and  becoming  at  such  date  a  definite 
liability  of  the  issuing  corporation.  The  number  of  coupons 
attached  to  such  a  bond  depends  upon  the  number  of  years  the 
bond  runs  and  the  number  of  interest  periods  within  the  full 
term. 

Each  coupon  should  be  detached  when  due,  and  then  be  pre- 
sented for  payment,  payment  usually  being  made  through  the 
bank  of  the  investor  who  holds  the  bond.  The  investor  usually 
deposits  them  in  his  bank  account,  and  the  bank  accepts  them 
for  collection.  Since  coupon  bonds  are  negotiable,  the  holder 
of  an  interest  coupon  is  entitled  to  have  the  interest  paid  to  him 
when  he  presents  the  coupon  for  payment,  provided  it  is  due. 
A  coupon  does  not  bear  interest  after  due  date.  Since  these 
bonds  usually  are  payable  to  bearer,  and  since  the  coupons  are 
payable  to  bearer,  title  passing  by  delivery,  the  investing  publico 
considers  such  bonds  decidedly  convenient  for  speculative 
purposes. 

The  coupons  are  numbered  in  the  order  of  their  maturity. 
As  coupons  are  paid,  the  issuing  corporation  collects  and  cancels 
them.  After  cancellation,  the  coupons  are  pasted  into  a  specially 
prepared  coupon  book  being  kept  therein  as  evidence  that  the 
interest  has  been  paid.  Upon  this  record,  the  coupons  may  be 
arranged  in  the  order  of  their  numbers, — Coupon  No.  1,  from 
all  bonds  being  together,  then  Coupon  No.  2,  and  so  on. 

Coupon  bonds,  at  times,  may  contain  a  clause  providing  for 


INVESTMENTS:  STOCKS,  BONDS  AND  MORTGAGES      187 

their  conversion  into  registered  bonds.  When  a  coupon  bond  is 
exchanged  for  a  registered  bond,  all  interest  coupons  past  due 
must  be  detached  and  cancelled.  Likewise,  all  coupons  that  are 
to  mature  subsequently  must  be  attached  to  the  bond  when  the 
latter  is  surrendered. 

The  form  of  a  coupon  bond  does  not  differ  materially  from 
that  of  a  registered  bond.  It  would  have  a  different  name  and 
recite  that  the  interest  is  payable  upon  presentation  of  the 
attached  coupons  as  they  mature. 

If  a  company  has  both  forms  of  bonds  outstanding,  registered 
and  coupon,  care  must  be  observed  to  preserve  an  accurate 
record  thereof.  As  concerns  the  registered  obligations,  the  record 
therefor  was  described  in  the  last  section;  this  will  be  entirely 
satisfactory.  But  as  regards  the  coupon  bonds,  the  record  of 
ownership  cannot  be  made  entirely  in  a  satisfactory  manner, 
due  to  the  fact  already  indicated  that  ownership  may  be  trans- 
ferred without  formality  of  any  kind.  Therefore,  in  the 
accounts,  the  outstanding  amount  of  coupon  bonds  will  be  shown 
in  one  amount.  It  might  be  advisable,  however,  to  carry  upon 
the  Registered  Bond  Ledger  an  account  to  show  the  total  out- 
standing amount  of  coupon  bonds. 

A  coupon-bearer  bond  may  have  on  its  back  a  printed  space 
in  which  the  owner  may  indicate  his  ownership  in  writing.  If 
filled  out  properly,  this  bond  then  may  be  registered  upon  the 
books  of  the  company  so  that  subsequently  no  transfer  thereof 
will  be  possible  until  the  registered  owner  has  made  a  proper 
assignment.  In  this  case,  registration  will  not  apply  to  the  inter- 
est coupons,  the  latter  being  payable  to  bearer  as  before.  Often 
a  bond  issue  may  be  either  coupon  or  registered  at  the  option 
of  the  purchasers. 

Mortgage  Bonds. — Mortgage  bonds  are  secured  by  a 
mortgage  on  a  company's  property.  Against  such  property, 
usually,  they  are  first  mortgage  liens  taking  precedence  over 
every  other  claim  in  every  case  except  taxes  and  receivers'  cer- 
tificates where  the  latter  are  in  use.  First  mortgage  obligations 
must  be  satisfied  before  second  or  subsequent  mortgages  are 
satisfied.  A  second  mortgage  issue  may  be  made  where  the 
first  issue  is  small  as  compared  to  the  value  of  the  property. 

Mortgage  bonds  are  based  upon  a  trust  deed  mortgaging  the 


illl 


188 


ADVANCED  ACCOUNTING 


specific  property,  the  trustee  being  either  an  individual  or  a 
trust  company,  usually  the  latter. 

Collateral  Trust  Bonds. — These  are  used  mostly  by  rail- 
roads. Many  railroads  own  large  blocks  of  stocks  and  bonds 
of  subsidiary  companies  or  proprietary^  lines.  These  securities 
are  used  as  collateral  by  the  main  company,  being  placed  in  the 
hands  of  a  trustee  to  form  the  security  of  tlie  bonds.  A  col- 
lateral trust  agreement  is  executed  and  delivered  with  these 
securities  to  the  trustee  to  secure  the  payment  of  the  bonds. 

Usually,  the  securities  given  are  in  excess  of  the  bond  issue. 
The  income  from  these  securities  is  used  by  the  trustee,  first,  to 
pay  the  interest  upon  the  bonds  and,  second,  to  become  part  of 
the  sinking  fund  set  up  for  their  redemption. 

If  the  collateral  consists  of  the  stock  of  subsidiary  companies, 
the  bonds  are  no  better  than  the  stock  they  represent.  If  the 
collateral  consists  of  notes  receivable  taken  for  loans  made, 
these  being  secured  by  real  estate  mortgages,  the  mortgages  are 
given  to  the  trustee  and  bonds  of  convenient  form  are  issued 
against  them;  the  effect  here  is  to  separate  a  large  mortgage  into 
small  parts  to  enable  a  small  investor  to  place  his  small  funds 
to  good  use,  as  a  revenue  producer. 

Miscellaneous  Classes  of  Bonds. — Some  of  the  classes  of 
bonds  not  mentioned  above  are  explained  briefly  hereunder: 

1.  Equipment  bonds.  These  are  secured  by  a  mortgage  upon 
a  corporation's  equipment.  They  are  peculiar  to  railroads, 
in  which  case  they  are  secured  by  a  mortgage  on  the  rolling 
stock. 

2.  Car  trust  certificates.  These  are  a  peculiar  type  of  bond 
used  by  railroads  to  pay  for  their  equipment,  constituting  a 
first  lien  on  locomotives,  passenger  and  freight  cars.  They 
are  issued  to  an  amount  equal  to  80  per  cent  of  the  cost  of 
the  equipment  and,  usually,  they  are  in  serial  form,  one 
series  falling  due  each  year.  Their  use  permits  the  railroad 
to  pay  for  its  equipment  on  the  instalment  plan.  The  title 
to  the  equipment  remains  in  the  holders  of  the  certificates 
until  the  last  certificate  is  paid ;  this  means  that  the  security 
increases  each  year  in  the  same  ratio  as  the  company's 
equity.  Car  trust  certificates  carry  a  high  rate  of  interest, 
are  readily  marketable  but,  being  much  in  demand  by  large 


INVESTMENTS:  STOCKS,  BONDS  AND  MORTGAGES     189 

investors,  seldom  reach  the  regular  market.    They  may 
have  coupons  attached  to  them. 

3.  Receivers'  certificates.  When  a  railroad  goes  into  receiver- 
ship, its  affairs  practically  are  in  control  of  the  Court.  In 
order  to  meet  emergency  or  maintenance  expenditures,  the 
Court  may  authorize  the  issuance  of  receivers'  certificates. 
They  are  an  extraordinary  means  made  use  of  to  protect 
creditors  and  to  prevent  unnecessary  loss  or  waste  of  assets. 
Such  certificates  have  a  priority  over  first  mortgage  bonds 
and  over  all  other  claims. 

4.  Prior  lien  bonds.  These  have  a  prior  lien  upon  all  the 
assets  of  a  corporation.  Receivers'  certificates  are  an  ex- 
ample of  prior  lien  bonds. 

5.  Adjustment  bonds.  Sometimes,  when  a  railroad  is  in  the 
hands  of  a  receiver,  the  other  bondholders  may  be  forced  to 
make  a  settlement;  this  leads  to  an  issue  of  what  are  known 
as  adjustment  bonds. 

6.  Consolidated  mortgage  bonds.  If  a  corporation  has  too 
many  outstanding  bond  issues  and  business  becomes  bad, 
it  may  not  be  able  to  pay  all  the  interest  out  of  the  income. 
When  such  is  the  case,  some  sort  of  a  reorganization  will 
be  necessary  for  purposes  of  safety.  Frequently,  when  this 
happens,  the  various  outstanding  bond  issues  are  consoli- 
dated into  one  issue  which  carries  a  lower  rate  of  interest. 
The  bondholders  accept  the  new  bonds  in  exchange  for  the 
old,  upon  some  agreed  basis,  because  this  is  perhaps  the 
only  way  out  of  a  bad  situation.  Again,  these  bonds  may 
be  issued  to  raise  new  capital,  to  unify  outstanding  issues, 
or  to  retire  certain  outstanding  issues,  without  the  reorgani- 
zation element  entering  into  consideration. 

7.  Refunding  bonds.  If  a  sinking  fund  (see  discussion  in  later 
chapter)  proves  inadequate  for  redeeming  maturing  bonds, 
a  new  issue  may  be  financed  to  fund  the  old  outstanding 
issue.  Such  new  issue  would  be  classed  as  refunding  bonds. 
The  consolidated  mortgage  bonds  above  mentioned  fall 
within  this  group. 

8.  Debenture  bonds.  This  class  of  bonds  has  two  meanings 
depending  upon  the  type  of  the  issuing  corporation: 


1 


ilfil 


■i 


190 


ADVANCED  ACCOUNTING 


a.  Debenture  bonds  of  financial  institutions.  These  bonds 
pledge  first  mortgages  owned  by  the  company  which 
issues  the  instruments  of  credit. 

b.  Debenture  bonds  of  railroads,  and  the  ordinary  deben- 
ture. These  bonds  are  not  seciu-ed  by  anything,  being 
nothing  more  than  a  formal  acknowledgment  of  a  debt, 
under  seal.  Since  they  carry  no  special  pledge  of  cor- 
porate property  to  secure  them,  they  may  be  considered 
as  formal  unsecured  notes  (promissory)  carrying  coupons 
to  assist  in  the  payment  of  interest.  They  constitute 
a  charge  against  a  corporation's  general  assets,  not 
against  any  particular  class  of  assets.  As  concerns  the 
interest  payable  thereunder,  they  present  the  same  gen- 
eral characteristics  as  income  bonds. 

In  England  it  seems  that  all  bonds  are  called  debentures. 

9.  Income  bonds.  These  bonds  partake  of  the  nature  of  both 
preferred  stock  and  debenture  bonds  in  that  they  possess 
characteristics  of  both.  They  are  not  necessarily  issued 
upon  the  security  of  any  tangible  property  but  depend  for 
payment  usually  upon  the  net  income  of  the  corporation 
both  as  to  principal  and  as  to  interest.  It  may  be,  how- 
ever, that  the  principal  sum  will  be  secured  by  a  pledge  of 
specific  property,  or  by  a  preference  claim  against  certain 
corporate  property.  Interest  is  payable  always  only  out  of 
net  income,  and  only  after  all  other  fixed  charges  have  been 
paid;  in  this  they  resemble  preferred  stock.  Likewise,  as  to 
interest,  they  may  be  either  cumulative  or  non-cumulative; 
in  this,  they  resemble  preferred  stock.  If  non-cumulative, 
the  coupons  for  any  one  year  cannot  be  cashed  when  suffi- 
cient net  income  has  not  been  earned  wherewith  to  pay 
them.  Income  bonds,  in  the  matter  of  security,  resemble 
the  ordinary  debenture.  They  differ  therefrom  in  that  they 
constitute  a  first  lien  against  profits  and  no  dividends  can 
be  paid  until  they  have  been  taken  care  of. 

10.  Deferred  bonds.  These  are  somewhat  in  the  nature  of  an 
indefinite  or  perpetual  loan,  which  may  or  may  not  be 
redeemed  at  face  value.  The  payment  of  interest  may  be 
contingent  upon  the  happening  of  some  event ;  or  the  inter- 
est may  be  paid  at  a  graduated  rate  up  to  a  certain  point 


«f| 


INVESTMENTS:  STOCKS,  BONDS  AND  MORTGAGES      191 

which,  when  reached,  means  they  must  be  converted  into 
active  bonds. 

11.  Bottomry  and  respondentia  bonds.  These  two  classes  are 
peculiar  to  shipping.  A  bottomry  bond  is  a  conveyance 
under  which  the  owner  or  the  master  of  a  ship  pledges  his 
ship  as  security  for  some  obligation.  If  the  ship  should  be 
lost,  the  bondholder  loses  his  security.  A  respondentia 
bond  is  a  conveyance  under  which  the  cargo  of  a  ship  is 
pledged  as  security  for  some  obligation. 

12.  Gold  bonds.  The  principal  and  interest  of  these  bonds  are 
payable  in  gold  coin  of  equal  weight  and  fineness  with  the 
present  coinage,  or  its  equivalent.  When  bonds  are  classi- 
fied according  to  the  exchange  medium  in  which  redeem- 
able, they  would  be  grouped  as  gold  bonds,  silver  bonds, 
and  currency  bonds. 

13.  Governmental  bonds.  The  usual  division  of  these  bonds 
would  be: 

a.  U.  S.  Government  bonds.  These  are  issued  by  the  Fed- 
eral Government  under  authority  of  Congress  for  various 
purposes  such  as  carrying  on  war,  replenishing  a  depleted 
treasury,  etc.  They  are  issued  on  the  credit  of  the 
Government. 

b.  State  bonds.  These  bonds  are  issued  by  a  State  for 
public  improvements. 

c.  Municipal  bonds.  These  are  issued  by  cities  for  various 
purposes  such  as  the  making  of  public  improvements, 
purchasing  a  public  utility  enterprise,  etc.  Although 
they  are  considered,  as  a  rule,  to  be  a  good  investment, 
the  issue  under  a  purchase  contemplation  should  be 
scrutinized  most  carefully;  if  any  irregularity  has  crept 
into  carrying  out  of  the  statutory  regulations  thereon, 
the  issue  will  be  invalid. 

In   contradistinction   to   government   bonds,   other   bonds 
may  be  termed  as  "commercial." 

Loans  Secured  by  Collateral.— Loans  secured  by  collateral 
may  be  separated  as  follows: 

1.  Time  loans.    A  time  loan  is  made  for  a  definite  period  of 
time;  it  cannot  be  liquidated,  i.  e.,  repaid,  until  maturity 


192 


ADVANCED  ACCOUNTING 


unless  the  lender  agrees  thereto  either  for,  or  not  for,  a 
consideration. 

2.  Call  loans.  A  call  loan  is  not  made  for  a  definite  period 
of  time;  it  may  be  repaid  at  any  time  according  to  the 
wish  of  either  the  lender  or  the  borrower. 

The  collateral  pledged  as  security  for  these  loans  may  be  secur- 
ities, or  almost  anything  else.  In  any  event,  the  pledge  will 
have  a  market  value  higher  than  the  amount  of  the  loan,  the 
excess  depending  upon  the  wishes  of  the  lender.  If  the  markc^t 
value  of  the  collateral  drops  so  that  the  excess  thereof  over  the 
amount  of  the  loan  becomes  less  than  the  value  as  on  the  day  the 
loan  was  negotiated,  new  security  may  be  demanded  to  cover  the 
existing  difference.  The  collateral  pledged  may  be  changed  at 
any  time  by  the  borrower  provided  the  new  collateral  is  as  accept- 
able to  the  lender  as  was  the  original.  If  the  borrower  defaults, 
the  collateral  held  by  the  lender  may  be  sold,  and  the  sales  pro- 
ceeds applied  to  the  extinguishment  of  the  debt;  any  excels 
remaining  after  such  application  must  be  turned  over  to  the 
borrower,  the  former  owner  of  the  collateral. 

The  accounting  for  loans  secured  by  collateral,  whether  time 
loans  or  call  loans  revolves  around  the  method  of  recording  the 
pledged  collateral  and  of  showing  in  the  same  record  in  connec- 
tion therewith  the  amount  of  the  loan. 

In  this  connection  a  card  record  may  prove  entirely  satisfac- 
tory, one  loan  per  card.  Each  loan  is  given  a  number  which  is 
placed  upon  the  card  in  the  upper  right-hand  corner.  Then  the 
name  of  the  borrower,  his  address,  and  the  terms  of  the  loan 
would  be  recorded.  Next,  information  concerning  the  amount 
of  the  loan,  per  cent  of  margin,  interest  rate,  date  of  loan,  interest 
payment,  and  collateral  maturity  should  be  shown.  Lastly,  the 
body  of  the  card  would  be  ruled  to  show  date  given,  description 
of  collateral,  quantity,  market  value,  and  total  value.  Each 
time  the  collateral  is  changed,  the  new  particulars  would  be 
added  and  the  old  crossed  off. 

Stock  and  Bond  Values.— Stocks  and  bonds  have  the  follow- 
ing distinct  values,  to  which  reference  already  has  been  made: 
1.  Par   (nominal)   value.     This  is  the  face  value,  the  value 

shown  on  the  face  of  the  document  in  question.    Such  value 

may  or  may  not  be  the  actual  value. 


INVESTMENTS:  STOCKS,  BONDS  AND  MORTGAGES      193 

2.  Market  value.  This  is  the  value  a  security  has  in  the  open 
market,  or  when  offered  for  sale.  Such  value  fluctuates  ac- 
cording to  conditions,  future  prospects,  or  according  to 
supply  and  demand.  Ordinarily,  it  may  be  considered  as 
the  mean  between  the  price  asked  and  the  price  bid.  If  an 
investment  is  to  be  considered  as  permanent,  the  principal 
must  be  looked  upon  as  being  safe  and  the  income  there- 
from as  being  constant  and  reliable.  Because  of  this  fact, 
the  market  price  of  bonds  is  not  apt  to  fluctuate  as  much 
as  the  market  value  of  stocks.  This  steadiness  permits 
the  investor  to  rely  upon  the  possibility  of  realizing  upon 
them  in  an  emergency,  either  through  sale  or  by  using  them 
as  collateral  for  a  loan.  In  the  case  of  stock,  this  possibil- 
ity is  decidedly  uncertain  because  just  when  an  investor 
requires  his  stock  for  one  of  these  purposes,  the  chances 
are  excellent  that  the  market  will  have  dropped  to  such 
a  point  that  the  stock  will  be  useless  in  this  connection. 

3.  Intrinsic  value.  This  is  the  actual  amount  which  the  stock- 
holders or  bondholders  will  receive  when  the  affairs  of 
the  corporation  are  wound  up. 

4.  Book  value.  In  addition  to  the  above,  stocks  have  what  is 
known  as  book  value.  This  is  the  value  of  the  stock  as 
shown  by  the  corporate  books ;  for  example,  the  value  repre- 
sented by  assets  less  liabilities. 

Proprietorship  Versus  Loan  Investments.— Security  invest- 
ments may  be  classified  in  a  number  of  ways  depending  upon 
the  viewpoint.  Up  to  the  present  moment,  one  classification 
thereof  has  been  indicated: 

1.  Stocks  versus  bonds. 

and  to  this  may  be  added  the  following: 

2.  Proprietorship  versus  loan. 

3.  Speculative  versus  non-speculative. 

4.  Temporary  versus  permanent. 

The  primary  discussion  in  this  chapter  revolves  around  the 
first  and  second  groupings  as  such.  The  others,  as  a  matter  of 
fact,  represent  merely  a  restatement  of  the  first. 

If,  when  one  speaks  of  investments,  he  has  in  mind  investment 
securities,  and  nothing  else,  the  following  classification  results: 

L  Stocks. 

2.  Bonds. 


194 


ADVANCED  ACCOUNTING 


Hereunder  a  short  term  note  is  considered  a  form  of  bond.  If 
a  person's  investments  consist  of  stocks,  he  is  said  to  have  made 
a  proprietorship  investment;  whereas,  if  his  investments  consist 
of  bonds,  he  is  said  to  have  made  a  loan  investment, — an  invest- 
ment contemplating  an  interest  return.  There  is  an  uncertainty 
about  a  proprietorship  investment  in  that  a  return  will  be  secured 
therefrom  only  if  a  profit  is  made. 

Investment  in  the  stock  of  a  business  does  not  necessarily 
mean  an  investment  made  for  a  definite  period  of  time ;  in  fact, 
the  length  of  the  period  is  indefinite  being  limited,  in  general, 
only  by  the  life  of  the  concern  whose  stock  is  held.  No  return 
is  secured  from  a  stock  investment  until  a  dividend  has  been 
declared  by  the  board  of  directors  of  the  company  represented  by 
the  stock  held.  The  payment  of  dividends  depends  upon  profits 
earned;  if  profits  have  not  been  earned,  legally,  no  dividends 
should  be  declared.  Therefore,  dividends  never  should  be  ac- 
crued. The  uncertainty  of  a  return  therefrom,  and  the  insecurity 
of,  a  stock  investment  in  comparison  to  the  certainty  of  a  return 
from,  and  the  security  underlying,  a  loan  investment,  make  the 
former  one  of  a  purely  speculative  character.  The  holder  has 
a  certain  proprietorship  interest  in  the  concern  which  gives  him 
some  voice  in  its  management. 

The  loan  type  of  investment  covers  the  advancing  of  funds  for 
a  definite  period,  anywhere  from  one  year  to  fifty,  during  which 
a  fixed  rate  of  interest  return  will  be  received,  and  at  the  end 
of  which  the  principal  sum  advanced  must  be  refunded  to  the 
lender.    Certain  peculiar  characteristics  are  noticed  hereunder: 

1.  In  general,  security  is  demanded  before  the  loan  will  be 
made.  This  security,  in  part,  takes  the  form  of  a  negotiable 
instnunent  which  becomes  due  at  a  definite  future  date. 
The  investor,  therefore,  secures  two  clear-cut  promises: 

a.  A  promise  that  the  loan  will  be  repaid  on  a  definite 
future  date. 

b.  Due  to  the  element  of  negotiability  in  the  instrument 
as  referred  to,  a  promise  that,  if  he  so  desires,  he  may 
dispose  of  the  negotiable  instrument  security  at  any  time 
by  sale. 

2.  A  fixed  rate  of  return  is  promised  in  the  form  of  interest 
this  being  a  definite  percentage  computed  upon  the  face 


INVESTMENTS:  STOCKS,  BONDS  AND  MORTGAGES      195 

value  of  the  loan.     The  return,  therefore,  may  be  deter- 
mined readily. 

3.  In  general,  specific  property  is  pledged  as  security  for  the 
ultimate  repayment  of  the  loan.  For  example,  a  bond 
and  mortgage  on  real  estate  may  be  given  as  security  for 
the  loan. 

4.  The  holder  of  the  security  has  no  right  of  management  in 
the  business  to  which  the  loan  is  made.  As  long  as  no 
default  is  made  concerning  the  provisions  underlying  the 
loan,  the  management  can  act  as  it  sees  fit,  without  regard 
to  the  lender,  or  to  the  views  of  the  latter. 

Although  the  market  value  of  a  loan  security  may  fluctuate, 
the  fluctuation  will  be  less  than  that  of  a  proprietorship  loan 
(stock).  However,  if  the  security  is  listed  upon  the  Exchange, 
the  fluctuation  may  become  of  such  a  character  as  to  be  sufii- 
ciently  interesting  to  an  investor  who  is  willing  to  take  a  specu- 
altive  chance  to  make  money  in  buying  and  selling  speculative 
securities. 

In  short,  the  loan  type  of  investment  carries  a  definite  and  se- 
cured return  in  the  form  of  interest,  and  in  the  ultimate  repay- 
ment of  the  loan  without  requiring  the  investor  to  participate 
in  any  way  in  the  management  of  the  borrowing  company.  By 
investing  in  such  securities,  one  is  assured  of  a  certain  income 
without  the  bother  and  annoyance  of  participating  in  a  business 
and  without  incurring  any  proprietorship  risk. 

Advances  which  differ  from  the  above  second  grouping  of 
investments  are  not  to  be  classified  under  the  same  subdivisions, 
since  they  are  too  temporary  in  their  nature.  Familiar  examples 
of  these  would  be:  credit  loans,  bank  loans,  discounting  com- 
mercial paper,  etc. 

Speculative  Versus  Non-Speculative  Investments— Tem- 
porary Versus  Permanent.— When  investments  are  made  with 
the  intention  of  retention  until  such  time  as  the  market  value 
shall  increase  to  a  point  at  which  the  investor  will  be  enabled 
to  sell  at  a  profit,  they  are  considered  as  speculative.  On  the 
other  hand,  when  investments  are  made  to  secure  an  income 
return  therefrom,  they  are  classed  as  non-speculative.  For  ex- 
ample:    The  laws  of  New  York  state  that  in  the  absence  of 


II 


196 


ADVANCED  ACCOUNTING 


specific  instructions  in  deeds  of  trust  or  wills,  tliose  charged  with 
the  administration  of  trust  funds  must  invest  in: 

1.  ^'Bonds  and  mortgages  on  unincumbered  real  property  in 
this  State  worth  50  per  cent  more  than  tlie  amount  loaned 
thereon. 

2.  The  securities  in  which  savings  banks  are  authorized  to 
invest." 

These  types  of  investments  contain  no  element  of  speculation; 
neither  would  they  be  classed  as  temporary. 

Speculative  investments  are  all  temporary  in  character,  and 
may  be  divided  as  between: 

1.  Securities  purchased  outright. 

2.  Securities  purchased  on  a  margin. 

The  first  class  mentioned  well  may  be  taken  care  of,  from  the 
point  of  view  of  record  making,  in  accord  with  the  ideas  set 
forth  below.  The  second  class  is  discussed  by  itself  in  a  separate 
section. 

The  characteristics  above  mentioned  in  respect  of  speculative 
investments  places  them,  so  to  speak,  in  the  same  category  with 
goods  and  commodities  in  that,  like  these  latter,  they  are  held 
for  the  purpose  of  making  a  profit  through  a  sale.  Therefore, 
they  should  be  booked  like  any  other  commodity,  i.  e.,  at  cost. 

Such  cost  price  includes  brokers'  fees  and  any  other  expenses 
incident  to  the  purchase  of  the  investment  in  question.  Some 
persons  insist  such  investments  should  be  recorded  at  par,— 
at  face  value  as  shown  upon  the  investment  certificate.  Sucli 
booking,  however,  would  seem  to  be  in  error  because  of  the 
fact  that  by  so  doing  a  profit  or  a  loss,  as  a  rule,  is  anticipated 
at  the  time  of  purchase;  whereas,  neither  of  these  elements  puts 
in  an  appearance  until  a  sale  is  made. 

The  record-keeping  for  such  investments,  on  the  whole,  is  a 
simple  matter.  An  account  may  be  opened  upon  the  General 
Ledger  with  each  such  investment  purchased,  or  one  account 
may  be  opened  thereon  titled  Investments  or  Securities,  this  be- 
ing backed  up  by  a  subsidiary  record  in  which  each  investment 
is  given  a  separate  account. 

Stocks  and  bonds  sometimes  are  bought  upon  a  margin,  for 
speculative  purposes.  Under  such  a  set  of  facts,  one  has  an  asset 
consisting  of  the  right  to  receive  the  delivery  of  the  securities 


:  1 


INVESTMENTS:  STOCKS,  BONDS  AND  MORTGAGES      197 

when  the  balance  of  the  purchase  price  has  been  paid.  This  asset 
is  offset  by  the  liability  of  the  purchaser  to  the  broker  for  an 
amount  equal  to  the  full  purchase  price,  less  the  margin  that 
has  been  deposited.  Ordinarily,  upon  the  Balance  Sheet,  securi- 
ties bought  upon  a  margin  should  be  carried  at  cost,  this  includ- 
ing the  broker's  fees  bearing  upon  the  purchase;  investment 
companies,  however,  for  Balance  Sheet  purposes,  would  value 
such  securities  at  market  prices. 

Since  the  broker  charges  interest  upon  the  difference  between 
the  amount  deposited  as  margin  and  the  purchase  price,  provi- 
sion therefor  must  be  made  in  the  accounts.  To  this  end,  the 
account  carried  with  the  security  in  question  should  be  charged 
with  the  amount  of  the  interest  and  this  charge  be  offset  by  a 
credit  to  the  broker's  account.  Likewise,  it  should  be  remem- 
bered, the  broker  will  allow  interest  in  favor  of  the  purchaser 
on  the  amount  deposited  with  him  as  margin.  This  allowance 
is  an  offset  to  the  charge  for  interest  mentioned  just  above. 

If  dividends  are  received  on  stocks  or  interest  is  received  on 
bonds,  by  the  broker  for  the  account  of  the  purchaser,  the  ac- 
counting therefor  may  be  carried  out  in  either  one  of  two  ways: 

1.  Charge  the  account  of  the  broker  and  credit  the  account 
with  the  investment. 

2.  Charge  the  account  of  the  broker  and  credit  an  income 
account. 

The  first  method  is  to  be  preferred  to  the  second  because,  by 
so  doing,  the  cost  of  the  investment  is  gradually  reduced  so  that, 
when  the  investment  is  sold,  the  owner  may  determine  the  net 
profit  or  loss  on  his  speculation,  all  elements  therein  having  been 
taken  into  consideration. 

At  any  time,  the  effect  of  the  entries  made  in  connection  with 

margin  investments  should  be  such  that  the  difference  between 

the  asset  and  the  liability  account  will  represent  the  net  equity 

of  the  purchaser  in  the  investment. 

Non-speculative  investments  are  of  two  t^pes: 

1.  Temporary.     This  type  contemplates  a  temporary  source 

of  income,  as  where  a  corporation  has  an  abundance  of  cash 

capital  and  cannot  profitably  invest  this  in  merchandise  or 

secure  an  acceptable  rate  of  interest  from  having  such  cash 

on  deposit.    In  such  event,  securities  may  be  purchased  to 


198 


ADVANCED  ACCOUNTING 


obtain  a  larger  income,  but  with  the  idea  of  converting, 
at  the  pleasure  of  the  corporation,  these  securities  into  cash 
when  additional  cash  funds  are  required. 
2.  Permanent.  This  type  relates  to  investments  made  in  order 
to  control  the  activities  of  another  concern,  or  investments 
made  of  reserve  funds. 

From  this  point  of  view,  it  is  difficult  to  state,  as  certain 
writers  do,  that  all  temporary  investments  contain  an  element  of 
speculation.  It  seems  fully  possible  that  a  temporary  invest- 
ment may  be  made  in  which  the  element  of  speculation  is  entirely 
lacking;  but  on  the  other  hand,  a  speculative  investment  cannot 
be  anything  but  temporary. 

If  the  element  of  speculation  be  eliminated  entirely,  it  would 
seem  that  non-speculative  investments  may  be  grouped  as: 

1.  Mortgages  receivable. 

2.  Loans  secured  by  collateral. 

3.  Stocks  and  bonds. 

a.  Parent  companies. 

b.  Subsidiary  companies. 

c.  Allied  companies. 

d.  Outside  companies. 

Investments  which  are  temporary  income  producers,  in  general, 
should  be  recorded  in  the  books  of  account  at  actual  cost  price.' 
This  is  the  simplest  way  because  no  one  knows  exactly  how  long 
they  are  going  to  be  held. 

As  interest  is  collected  thereon,  the  amount  would  be  credited 
to  an  account  of  Interest  Income-Investments,  the  total  amount 
of  this  account  eventually  disappearing  into  the  Profit  and  Loss 
account. 

When  an  investment  of  this  character  is  sold,  and  a  profit  or 
loss  thereon  is  involved,  the  proper  accounting  procedure  there- 
for would  be  to  credit  the  asset  account  carried  with  the  cost 
price  in  order  to  clo§e  it  and  to  credit  or  debit  a  nominal  account 
for  the  profit  secured  or  loss  suffered,  as  the  case  may  be.  The 
amount  of  such  profit  is  a  financial  income  item  and  the  amount 
of  such  loss  a  financial  expense  item. 

There  is  no  uniformity  in  booking  permanent  investments. 
The  point  to  remember  is  that  the  procedure  involved  becomet 


INVESTMENTS:  STOCKS,  BONDS  AND  MORTGAGES      199 

more  complicated  than  indicated  above  on  account  of  the  fact 
that  such  investments  are  purchased  under  an  intention  of  hold- 
mg  them  until  maturity.  In  general,  they  may  be  recorded  at 
cost  or  at  par,  depending  upon  the  desires  of  the  investor  rather 
than  upon  anything  else. 

If  recorded  at  cost,  the  matter  is  handled  as  indicated  above 
for  handling  investments  which  are  temporary  income  producers 
On  the  other  hand,  if  recorded  at  par,  it  may.  be  necessary  to 
account  for  the  amount  of  premium  or  discount  involved  in  the 
transaction  as  where  the  purchase  was  made  either  above  or 
below  par,  as  the  case  may  be.  This  point  will  be  discussed 
later. 

Bonds  as  Investments.— As  an  investment  security,  a  bond 
offers  a  fixed  interest  return  and  repayment  of  the  principal  at 
a  specified  time.  Both  of  these  factors  are  secured  by  a  pledge 
of  property  which,  as  a  rule,  is  in  the  form  of  a  first  lien.  Since 
a  bond  carries  with  it  no  management  responsibility,  and  since 
both  the  income  therefrom  is  fixed  and  repayment  definite  as  to 
time,  the  speculative  element  present  is  much  less  than  that  pres- 
ent when  one  makes  a  stock  investment.  In  the  latter  event 
there  is  an  indefinite  profit  return,  no  dividend  being  possible 
unless  there  are  net  profits  available  for  distribution. 

The  fundamental  differences  between  stocks  and  bonds  is 
accountable  for  the  differences  that  arise  in  the  accounting  treat- 
ment accorded  each.  And  this  accounting  treatment  revolves 
around  three  definite  factors  which  may  be  stated  about  as 
follows: 

1.  Purchase. 

2.  Amortization. 
.  3.  Sale. 

In  buying  a  bond  and,  also,  in  selling  a  bond,  three  factors 
must  be  considered: 
1.. Par  value. 

2.  Interest  return. 

3.  Sales  price. 

A  bond  may  be  purchased  privately,  which  is  more  or  less 
unusual,  or  it  may  be  bought  in  the  market.  In  the  latter  event, 
the  market  is  created  through  the  power  of  some  Stock  Ex- 
change, as  the  New  York  Stock  Exchange;  this  latter  organiza^ 


«  1   ; 


200 


ADVANCED  ACCOUNTING 


tion  is  the  principal  bond  market  in  the  United  States.  A  broker, 
for  example,  who  is  a  member  of  the  Exchange,  will  purchase  a 
bond  for  a  customer  when  ordered  to  do  so,  buying  at  market 
price,  and  charging  one-eighth  of  one  per  cent  on  the  par  of  the 
bond  for  his  services  regardless  of  what  the  market  price  may  be. 
When  a  bond  is  bought,  the  sales  price  paid  usually  will  include 
a  certain  amount  to  cover  the  interest  that  has  accrued  to  date 
from  the  last  interest  payment  date;  hence,  the  buyer  must  take 
this  element  into  consideration  when  booking  his  purchase. 

Accounting  For  Bonds  as  Investments— Simple  Pro- 
cedure.— The  accounting  methods  used  for  bond  purchases  vary 
with  the  volume  of  the  transactions  consummated  and  with  the 
desires  of  the  investor.  The  small  investor,  i.  e.,  the  person  who 
buys  a  few  bonds  as  a  permanent  or. a  temporary  investment, 
requires  no  elaborate  methods  of  accounting;  the  simplest 
method  is  the  best,  and  sufficient  has  been  presented  above,  per- 
haps, relative  thereto.  He  is  most  apt  to  carry  such  investments 
entirely  upon  a  cost  basis,  considering  any  premium  or  discount 
either  as  a  profit  or  a  loss  at  the  time  his  holdings  either  are  sold 
or  mature.  In  brief,  and  by  way  of  review,  the  method  advised 
is  illustrated  by  the  following  account  of  Secm-ities  Owned. 

SEcrmrriES  Owned 


Debits: 

1.  Cost  of  stocks  and  bonds  pur- 
chased (issues  of  other  corpo- 
rations). 

2.  Amount  of  balance,  if  a  credit 
to  be  transferred  to  the  Profit 
and  Loss  account.  When  this 
entry  has  been  made,  the  ac- 
count should  be  closed. 

3.  After  debit  entry  No.  2  or 
credit  entry  No.  3  has  been 
made,  as  the  case  may  be,  this 
account  will  be  closed.  Thus 
the  inventory  at  the  end  of 
the  period,  as  per  credit  entry 
No.  2,  should  be  entered  below 
closing  ruling  as  the  beginning 
inventory  of  the  next  period. 


Credits: 

1 .  Sales  price  of  stocks  and  bonds 
sold  (issues  of  other  corpora- 
tions). 

2.  Inventory  of  stocks  and  bonds 
on  hand  at  end  of  period,  at 
cost  price. 

3.  Amount  of  balance,  if  a  debit, 
to  be  transferred  to  the  Profit 
and  Loss  account.  When  this 
entry  has  been  made,  the  ac- 
count should  be  closed. 


INVESTMENTS:  STOCKS,  BONDS  AND  MORTGAGES     201 

If  accrued  interest  is  involved  in  the  purchase,  the  purchaser 
must  take  this  up  separately  from  the  cost,  as  of  purchase  date, 
provided  he  wishes  his  accounts  kept  correctly.  Assume  that 
five  $1,000.00  5  per  cent  bonds  were  purchased  on  August  22,  at 
73  and  accrued  interest,  interest  being  payable  February  1,  Ind 
August  1.  On  August  22,  there  would  be  accrued  interest  of 
$14.58,  for  which  the  purchaser  must  pay.  In  other  words,  the 
total  cost  of  the  bonds  would  be: 


$5,(X)0.00— block  par  @  73, 

1/8  of  1  per  cent— broker's  commission, 

Accrued  interest,  5  per  cent  on  $5,000.00  for 
21  days, 

Total, 


$3,650.00 
6.25 

$3,656.25 

14.58 

$3,670.83 


Of  this  total,  $3,656.25  should  be  set  up  as  the  asset,  and  $14  58 
should  be  recorded  in  an  Accrued  Interest  account,  which,  later 
upon  the  next  interest  payment  date  must  be  credited  in  the 
amount  of  the  accrued  interest  as  of  the  purchase  date-  the 
remammg  portion  of  the  interest  collected  represents  the  amount 
that  actually  is  income  for  the  period  from  purchase  date  to 
February  1. 

However,  if  the  investor  wishes  to  use  a  more  accurate  account- 
mg  procedure  than  has  been  indicated  above,  he  may  follow 
either  of  two  possible  courses,  each  of  which  may  be  considered 
far  more  elaborate  than  the  simple  procedure  just  presented. 
Each  of  these  two  possible  variances  in  procedure  will  be  dis- 
cussed in  due  course  in  the  remaining  portion  of  the  present 
chapter. 

Bond  Premium  and  Discount;  Nominal  and  Effective 
Interest  Rates;  Amortization  and  Accumulation.— Before 
proceeding  further,  it  seems  in  order  to  set  out  certain  defini- 
tions and  distinctions  necessary  to  an  understanding  of  what  is 
to  follow. 

Bonds  may  be  purchased  at  par,  above  par,  or  below  par.  If 
purchased  above  par,  they  are  said  to  have  been  bought  at  a 
"premium";  if  purchased  below  par,  they  are  said  to  have  been 
purchased  at  a  '^discount."  In  the  example  given  in  the  last  sec- 
tion above,  the  bond  was  purchased  at  a  discount;  and  in  just  the 
same  way  it  might  have  been  bought  at  a  premium,  say,  for  105. 


202 


ADVANCED  ACCOUNTING 


The  rate  of  interest  set  out  upon  the  face  of  a  bond  is  known 
as  the  ''nominal"  rate  of  interest;  it  may  be  at  any  amount  the 
issuing  company  desires.  This  nominal  rate  may  or  may  not 
be  equal  to  the  worth  of  money  upon  the  market  upon  the  day 
the  bond  is  purchased.  This  latter  rate  will  be  the  one  at  which 
the  bond  will  sell  for  if  issued  at  par  thereunder.  This  second 
rate  is  known  as  the  "effective"  rate,  upon  the  basis  of  which 
is  calculated  the  net  return  upon  the  amount  of  money  actually 
invested. 

If  a  bond  is  purchased  at  a  premium,  the  difference  between 
its  cost  and  par  will  be  a  loss  at  maturity,  since  at  that  time 
only  par  value  can  be  collected.  In  other  words,  disregarding 
current  market  fluctuations  up  and  down,  the  value  of  this  bond 
will  depreciate  in  proportion  to  the  lapse  of  time  between  the 
time  of  purchase  and  time  of  maturity.  This  loss,  or  premium, 
should  be  spread,  i.  e.,  amortized  over  the  life  of  the  bond 
rather  than  be  written  off  in  a  lump  sum  at  the  time  the  bond 
matures.  Amortization,  therefore,  may  be  defined  as,  "The 
gradual  extinguishment  of  the  amount  of  an  asset,  .  .  . 
by  prorating  it  over  the  period  during  which  its  benefit  will  be 
realized."  As  applied  to  bonds,  amortization  contemplates  the 
periodical  adjustment  of  the  amount  that  is  received  as  inter- 
est on  the  par  of  the  bond,  to  the  real  interest,— that  which  is 
received  upon  the  amount  actually  invested. 

In  other  words,  if  the  premium  is  held  as  an  asset,  and  all 
interest  actually  received  is  booked  as  income,  the  income  must 
be  overstated  during  the  interim  period  inasmuch  as  when  the 
bond  is  actually  redeemed,  the  books  will  hold  a  nominal  ele- 
ment that  must  be  written  off  at  that  time.  To  avoid  this 
lump  sum  loss  in  the  final  period  since,  as  a  matter  of  fact,  it 
has  been  accumulating  gradually  from  the  date  of  purchase  of 
the  bond,  there  is  written  off  each  year  against  the  amount  re- 
ceived as  interest  a  proportionate  amount  of  the  premium.  This 
process  of  writing  down  the  premium  is  known  as  "amortiaa- 
tion." 

On  the  other  hand,  if  a  bond  is  purchased  at  a  discount,  the 
difference  between  the  purchase  cost  and  par  will  be  a  profit 
at  maturity,  because  then  par  will  be  collected.  And  applying 
the  same  reasoning  here  as  was  set  out  above,— that  if  the  dis- 


li; 


't 


INVESTMENTS:  STOCKS,  BONDS  AND  MORTGAGES      203 

count  is  held  as  a  lump  sum  until  maturity,  the  books  will  hold 
a  nommal  element  representing  income  which  has  been  accumu- 
latmg  gradually  from  the  date  of  purchase  of  the  bond,  the 
income  for  the  entire  interim  time,  period  by  period,  has  not 
been  stated  correctly.  The  profit  on  the  money  invested  should 
be  spread  i.  e.,  accumulated,-added  to  the  cost  of  the  bond- 
little  by  little  over  its  life  so  that  at  maturity  the  book  value 
of  the  bond  will  have  been  built  up  (accumulated)  to  par     This 

vir^'fl^'f "!  ^T  ^^'  ^^''"^°^  ^°^  ^""^^^^  ^P  the  book 
value  of  the  bond  is  known  as  "accumulation." 

Of  course,  in  practice,  bonds  often  are  sold  before  maturity 
dates;  again,  they  may  be  held  for  speculation  rather  than  for 
purposes  o  investment.  If  either  of  these  two  possibilities  be 
m  contemplation,  all  the  principles  raised  in  the  present  section 
will  be  disregarded  entirely,  and  the  owner  of  a  bond  will  carry 
It  at  cost,  or  even  at  market. 

If  the  small  investor  wishes  a  more  accurate  accounting  pro- 
cedure than  has  been  indicated,  or  if  investments  in  bonds  form 
part  of  the  regular  business  operations  of  a  concern,  the  first 
step  necessary  will  be  to  keep  the  accounts  upon  an  investment- 
value  basis  rather  than  upon  a  cost-value  basis.  Basically 
hereunder  there  is  involved  a  more  or  less  elaborate  accounting 
procedure  relative  to  amortization  and  accumulation  plus  a  con- 
sideration of  both  the  nominal  and  effective  rates  of  interest. 
JNext,  a  decision  must  be  reached  as  to  the  following: 

1.  Shall  the  accounting  calculations  be  made  upon  an  approxi- 
mate basis  of  accuracy,  or 

2.  Shall  the  accounting  calculations  be  made  upon  a  strictly 
scientific  basis  of  accuracy? 

This  differentiation  will  be  discussed  fully  after  the  principles 
have  been  presented  leading  up  to  such  consideration. 

Ascertaining  Present  Value  of  a  Bond.^The  premium  or 
discount  on  a  bond  represents  a  deduction  from,  or  an  addition  to 
the  nominal  rate  of  interest  a  bond  carries.  The  nominal  ratJ 
of  interest  which  the  issuing  company  elects  to  have  its  bonds 
cariy  may  or  may  not  be  equal  to  the  worth  of  money  upon  the 
market,-the  interest  rate  at  which  the  bonds  would  sell  at  par 
If  issued  thereunder.     If  the  nominal  rate  of  interest  is  above 


m 


204 


ADVANCED  ACCOUNTING 


ii 


the  effective  rate  (market  rate),  the  bonds  will  sell  at  a  premium- 
and  if  the  rate  be  less,  they  will  sell  at  a  discount. 
Four  elements  enter  into  the  value  of  a  bond: 

1.  Sufficiency  of  security. 

2.  Rate  of  interest  return. 

3.  Number  of  interest  periods. 

4.  Time  the  bond  has  to  run. 

When  an  investor  contemplates  purchasing  a  bond,  he  should 
keep  m  mind  the  four  elements  shown  above  plus  both  the  nomi- 
nal and  effective  interest  rates.  Knowing  these,  he  is  in  a  posi- 
tion to  determine  whether  the  price  asked  is  right.  Illustrative 
of  this,  study  the  following  problem  and  its  different  methods 
01  solution. 

onJ^^:'^"'  ^T^"^  ^'  ^^^^'  ^  '"^^^  ^^^"«*^^  contemplates  purchasing 
uue  uecemt^r  31,  1923,  interest  payable  semi-annually.  The  bond  is  uJ 
be  purcha^  upon  a  6  per  cent  basis.     How  much  should  be  paid  for  i^ 

First  Solution.~The  bond  contains  ten  coupons,  each  for  $4.00. 
First  coupon  compounded  for  9  terms  at  3  per  cent. 
Second  coupon  compounded  for  8  terms  at  3  per  cent. 
Third  coupon  compounded  for  7  terms  at  3  per  cent 
Fourth  coupon  compounded  for  6  terms  at  3  per  cent, 
mh  coupon  compounded  for  5  terms  at  3  per  cent. 
Sixth  coupon  compounded  for  4  terms  at  3  per  cent, 
Seventh  coupon  compounded  for  3  terms  at  3  per  cent, 
^ighth  coupon  compounded  for  2  terms  at  3  per  cent. 
Nmth  coupon  compounded  for  1  term  at  3  per  cent, 
Tenth  coupon  compounded  for  0  term  at  3  per  cent, 
Total  coupons  compounded  to  time  of  redemption  ' 
Kedemption  value  of  bond  at  maturity 


5.219092 
5.067080 
4.919492 
4.776208 
4.637096 
4.502032 
4.370908 
4.243600 
4.120000 
4.000000 


I  45.855508 
100  000000 

$145.8555(» 


JLt;nd  "^Z^"^^?  """r^  ^"^  '^*^'"^  '^'  -"'--«  --d  redeeming 
tne  bond.     The  amount  mvolved,  however,  is  to  make  $140  00  plus  interest 

t    wCt  Z!::t^'^'1  «enn-annuaUy,-$5.855508.     Ne*^  ^^^^^Z 

^    amount    to    SlWS855'rSvlL^^^^^^^ 

pS^o'^h^Ta^  8';eTir$i*So^rond^"  ''''' f''''  '''^''^^^ 
income  of  6  per  cent.'crm^lTselt^^^^^        '^^  ^^^"'  ^^^^^  ^^ 

Second  Solution.^There  are  ten  coupons  accruing  interest  at  3  per  cent. 


INVESTMENTS:  STOCKS,  BONDS  AND  MORTGAGES      205 

t^e^run^n^wM^r^^^  ^^^^  ^^^  «*^-  -  known  and 

C,  the  first  quantity,  is  the  coupon,  ^  f^ 

M  lu*  T^^f  quantity,  is  the  ratio  to  the  buyer,  i  03 

N,  the  third  quantity,  is  the  number  of  terms  in 

Th3        iT*'^  ""''"'"y-  '"  •">k''own,-the  sun^  of  the  series  ? 

These  quantities  may  be  arranged  into  the  appearance  of  a  formula- 

CR°  -  C  ^ 

JowerTthTnoit-  •  ™V!,r'V"''  ''^  "'^  ^''°  '"^  raised  to  the  10th 
pXt't  sEc^^trfi^f  It-thatV'^'r^-  th'-^"  ''Z  ''' 

totellntelt  on  tL  T"  '""°"°*''  ^'''^  ^  '<«"'*  -^Presenting  the 

total  mterest  on  the  series  of  coupons,  which  is  $1.375664.     This  interest 

Lta^IdTl,^  -' 3  ?tr''  °:  .^If  '"^  "'  '""^  ""-•     Now,  since  3  is 

33  1/3  b  theLe^iv^Lgbf  63  (theeo;,  r    '^'*''--    ^^^'^P'^^^  ^y 
will  reHup*  IK.  ™  =»  uiviaing  Dy  .03  (the  equation  denominator).     Nothing 

^  il^  rii^hms""'''''  ''''"''  '"'''''''  '"  ^""°«  »"-  -•"*-.  -ept 
or  S^viu^T^^hTh '^H  T't"""  °i  """*'°"  »  *"  P'<"'««d  from  the  maturity 

Maturity  value,  par, 

Add-Interest  due  9  terms  from  present,  or  1  from  maturity, 


Discount  tins  amount  by  dividing  by  1.03,  the  effective  rate  - 
Lt  b^^atuS"  '^"^"^  '''  ^^-  ''  '''  '-^  ' 

''r2Tom"t;S; '""  ^^"'^'^  '^^ '  ^"^^^  ^^^^ '--'' 

Discount  this  amount  by  dividing  by  1.03,  as  above. 

maturitT*^   '''   '^'^  ^'   ''^   '^^^   '   ^^^'^   ^^^- 
To  secure  next  value,  add  coupon  due  7  terms  from  present 
or  3  terms  before  maturity,  present, 

Discount  this  by  dividing  by  1.03. 

Value  of  bond  3  terms  before  maturity 
Add  coupon  due  6  terms  from  pre8ent-4'  from  maturity, 


$100.000000 
4  000000 

$104.000000 


$100.970873 
4.000000 


$104.970873 


SlOl. 913449 
4.000000 


1105.913449 

$102.828785 
4000000 

1106.828785 


\ 


206 


ADVANCED  ACCOUNTING 


'I ' 


'i 


«. 


(i 


Discount  by  dividing  by  1.03. 

Value  of  bond  4  terms  before  maturity, 
Add  coupon  due  5  terms  from  present— 5  from  maturity, 

Discount  by  dividing  by  1.03. 

Value  of  bond  5  terms  before  maturity, 
Add  coupon  due  4  terms  from  present— 6  from  maturity, 

Discount  by  dividing  by  1.03. 

Value  of  bond  6  terms  before  maturity. 
Add  coupon  due  3  terms  from  present— 7  from  maturity, 

Discount  by  dividing  by  1.03. 

Value  of  bond  7  terms  before  maturity 

Add  coupon  due  2  terms  before  present— 8  before  maturity, 

Discount  by  dividing  by  1.03. 

Value  of  bond  8  terms  before  maturity. 
Add  coupon  due  1  term  from  present— 9  before  maturity, 

Discount  by  dividing  by  1.03. 

Value  of  bond  9  terms  before  maturity. 
Add  coupon  due  0  terms  from  present— 10  before  maturity, 

Discount  by  dividing  by  1.03. 
Value  of  bond  10  terms  before  maturity— at  present, 
The  present  worth  of  the  bond  is  seen  to  be  the  same  as 
before,  $108.53. 

Schedule  of  Amortization.— When  the  above  bond  is 
brought  upon  the  books  of  the  purchaser,  the  latter  might  follow 
any  one  of  three  procedures,  as  to  booking: 

1.  The  simple  method,  as  explained  above. 

2.  The  amortization  methods. 

a.  Simple  procedure — non-scientific. 

b.  Scientific  procedure. 

Naturally,  since  the  above  bond  is  of  such  a  small  amount, 
the  owner  is  not  apt  to  follow  a  more  or  less  scientific  procedure 
relative  thereto,  but  if  he  wished  to  do  so,  the  preparation  of  an 
amortization  schedule  would  be  in  order.  The  first  schedule 
shown  below  has  been  prepared  upon  what  is  known  as  the  non- 
scientific  basis.  The  second  schedule  follows  the  first  one  as  t^) 
pnnciple,  but  involves  a  more  elaborate  calculation;  hence,  may 


1103.717267 
4000000 

1107.717267 


$104.579871 
4.000000 

$108.579871 


$105.417360 
4.000000 

$109.417350 


$106.230437 
4000000 

$110.230437 


$107.019842 
4  000000 

$111.019842 


$107.786254 
4000000 

$111.786254 


$108.530344 


INVESTMENTS:  STOCKS,  BONDS  AND  MORTGAGES     207 

be  termed  the  scientific  basis,  in  that  the  difference  between  the 
actual  income  and  the  effective  income  is  calculated  as  ac 
curately  as  possible  at  each  interest  paying  date  and  is  used  to 
reduce  the  carrying  value  of  the  bond.  The  scientific  calculation 
may  or  may  not  be  based  upon  bond  tables;  naturally,  the 
element  of  error  creeps  in  without  their  use,  as  will  be  noticed 
subsequently. 

Schedule  of  Amortization 


Period 


Period 


Coupons 
4  per  cent 


1 

$  4.00 

$  3.147 

2 

4.00 

3.147 

3 

4.00 

3.147 

4 

4.00 

3.147 

5 

4.00 

3.147 

6 

4.00 

3.147 

7 

4.00 

3.147 

8 

4.00 

3.147 

9 

4.00 

3.147 

10 

4.00 

3.147 

$40.00 


(Non-Scientific) 

Income  Net 

Approximate     Amortization 


853 

.853 
.853 
.853 
.853 
.853 
.853 
.853 
.853 
.853 


$31,470 


$8  530 


Book 
Value 

$108,530 
107.677 
106.824 
105.971 
105  118 
104.265 
103.412 
102.559 
101.706 
100.853 
100.000 


Schedttle  of  Amortization 

8  per  cent— -Five  Year  Gold  Bond 

Nothen  Power  Company 

Redeemable  at  Par,  $100.00,  on  December  31.  TQgg 

Income  Rate  6  per  cent 

Coupons  Income  Net  Book 

4  per  cent  3  per  cent       Amortization  Value 


1 

$  4.00 

2 

4.00 

3 

4.00 

4 

4.00 

5 

4.00 

6 

4.00 

7 

4.00 

8 

4.00 

9 

4.00 

10 

4.00 

$  40.00 


$  3.2559 
3.2336 
3.2106 
3.1869 
3.1625 
3.1374 
3.1115 
3.0849 
3.0574 
3.0291 

$  31.4698 


$ 


.7441 
.7664 
.7894 
.8131 
.8375 
.8626 
.8885 
.9151 
.9426 
.9709 


$  8.5302 


108 

107 

107 

106. 

105. 

104. 

103. 

102. 

101. 

100. 

100. 


.5300 
.7859 
.0195 
.2301 
.4170 
5795 
7169 
8284 
9133 
9707 
0000 


208 


ADVANCED  ACCOUNTING 


The  discrepancy,  in  the  last  step,  being  but  two  points  in  the 
fourth  place,  is  not  sufficient  to  discredit  the  accuracy  of  the 
above  calculation.  Absolute  accuracy  may  be  secured  by  the 
use  of  bond  tables;  these  should  be  used  whenever  the  bond 
values  involved  are  of  considerable  size. 

Accounting  For  Bonds  as  Investments — Amortization 
Principle. — If  the  investor  wishes  to  use  a  more  accurate 
accounting  procedure  than  the  simple  method,  such  procedure 
will  revolve  around  one  or  the  other  of  the  amortization  sched- 
ules worked  out  above: 

1.  In  accord  with  the  simple  scheme  of  amortization,  or 

2.  In  accord  with  the  scientific  scheme  of  amortization. 
Either  one  of  these  methods  is  suggested  in  preference  to  the 

simple  method  of  booking  in  that,  if  the  books  of  the  investor 
do  not  consider  the  effective  rate  of  interest  upon  his  investment, 
he  cannot  tell  whether  a  proposed  sale  will  or  will  not  net  him 
a  profit.  And  by  considering  the  effective  rate,  the  investor  re- 
quires a  method  of  record  keeping  different  from  the  simple  one 
already  indicated. 

Under  the  simple  scheme  of  amortization,  the  investor  will 
take  the  total  premiimi  or  discount  and  divide  this  amount  by 
the  number  of  periods  the  bond  has  yet  to  run.  For  example, 
in  the  previous  explanation  or  illustration,  this  would  be  in  ac- 
cord with  the  non-scientific  schedule  of  amortization.  The  bond 
has  ten  periods  to  run.  The  total  premium  is  $8.53.  Therefore, 
the  net  amortization  each  period  would  be  $.853.  As  already 
indicated,  this  method  is  not  scientifically  accurate,  but  suffi- 
ciently so  for  working  purposes. 

In  connection  with  the  simple  or  non-scientific  scheme  of 
amortization,  the  accoimts  to  be  carried  will  be  similar,  as  to 
title,  to  those  carried  in  a  concern  in  which  investments  in  bonds 
are  part  of  the  ordinary  business  operations, — i.  e.,  in  a  concern 
using  the  scientific  scheme  of  amortization.  Likewise,  the  entries 
made  therein  will  be  the  same;  the  only  difference  will  be  as  to 
the  amounts  involved  in  such  entries. 

When  either  the  approximate,  or  the  true,  investment  value  of 
bonds  is  to  be  carried  upon  the  books  of  record,  the  following 
accounts  must  be  used: 

1.  One  account  for  each  bond  investment,  record  to  be  made 
therein  at  par. 


INVESTMENTS:  STOCKS,  BONDS  AND  MORTGAGES      209 

2.  One  account  with  accrued  interest,  if  any  is  involved 

3.  One  account  with  bond  income. 

4.  One  account  with  bond  premium. 

5.  One  account  with  bond  discount. 

If  bonds  are  purchased  between'  interest  dates,  a  certain 
amount  of  mterest  will  have  accrued  thereon  for  which  the  pur- 
chaser must  pay  Interest  on  a  bond,  it  should  be  remembered 
accrues  day  by  day,  but  is  not  payable  until  the  end  of  some 
fixed  period  Likewise,  when  the  books  are  closed,  accrued  in- 
terest  upon  bonds  held  must  be  calculated  and  booked,  miless  the 

rr  bTs-:."^  ""^'^  ^^^^  ^  ^^^^  '^^  ^-^^^  ^^  -^^  - 

o  per  cent  first  mortgage  bonds  due   Tnlv  l    looo   ;,,*       *  ^.umpany 

January  1,  1921 
Clair  Co.  Light,  Heat  and  Power  Co.  5 's— 1922       S.  <i  non  (vx 

T^^:^-^-  ^-  ^-  «•  *  ^-  ^o-  «'«.      ^^sZ 

To  record  purchase  of  bond.  $  2 ,075 .  00 

July  1.  1921 
Cash,  (2) 

To-Bond  Income,  $  50.00 

To  record  income  received.  S  50.00 

(3) 
Bond  Income, 

To-Bond  Premium-C.  C.  L.  H.  &  P.  Co.  5%         ^  ''  "^        •  25  00 
To  record   amortization   of  bond  premium, 
term  of  bond  being  three  periods,  1/3  to  be 
written  oflF  premium  each  period. 

January  1,  1922 

Cash,  (^) 

To-Bond  Income,  *  $50.00 

^  fR\  S  50.00 

Bond  Income,  ^  ' 

To-Bond  Premium-C.  C.  L.  H.  &  P.  Co.  S's.         *  ""^  °"        ,  35  00 


210 


1^ 


ADVANCED  ACCOUNTING 
July  1,  1922 


Cash, 

To — Bond  Income, 


(6) 


$  50.00 


$  50  00 


(7) 


$  25.00 


$  2A  00 


Bond  Income, 

To— Bond  Premium— C.  C.  L.  H.  &  P.  Co.  5'8, 

Date 

(8) 
Cash,  $2,000.00 

To — Clair  Co.  Light,  Heat  and  Power  Co.  5's,  $2,000  00 

To  record  redemption. 
The  Ledger  accounts  in  connection  with  the  above  are  as  follows: 
Clair  County  Light,  Heat  and  Power  Co.  5's — 1922 
1921  1922 

Jan.  1— Cash  (1),  $2,000.00         July  1— Cash  (2),  $2,000  00 


Bond  Premium 

1921 

1921 

Jan.  1— Cash  (1), 

$75.00 

July  1- 

-Bond  Income  (3),     $25  00 

1922 

' 

Jan.  1- 
Julyl- 

-Bond  Income  (5),       25  00 
-Bond  Income  (7),       26  00 

$75.00 

$76  00 

Cash 

1921 

1921 

July  1- 

-Bond  Income  (2). 

$50.00 

Jan.  1- 

-C.  C.  L.  H.  & 

1922 

P.  5'8(1),            $2,000  00 

Jan.  1- 

-Bond  Income  (4), 

50.00 

Bond  Premium  ( 1 ) ,    76 .  00 

July  1- 

-Bond  Income  (6), 

50.00 

1922 

C.  C.  L.  H.  & 

July  1- 

-Balance,                      75  00 

P.  5'8(8),              2,000.00 

$2,150.00 

$2,150  00 

July  1- 

—Balance, 

$75.00 

Bond  Income 

1921 

1921 

Julyl- 

-Bond  Premium  (3),  $25.00 

Julyl- 

-Cash  (2),                  $50  00 

1922 

1922 

Jan.  1- 

-Bond  Premium  (5) 

,    25.00 

Jan.  1- 

-Cash  (4),                     50  00 

July  1- 

-Bond  Premium  (7) 
Balance, 

,    25.00 

$75.00 
75.00 

$150.00 

July  1- 

-Cash  (6),                      50  00 

$150  00 

$150  00 

July  1- 

-Balance,                    $76.00 

mVESTMrnrS:  STOCKS,   BONDS  AND  MOHTGAGES       211 

anoe  in  the  Cash  tcoul".  '""'°'^'  """'  '^  ""^  ''''''''  '«''- 

Problem  2.— Suppose  in  Problem  No.  1   above   H    Inno=  i.  j  u       j 

accuracy  therein.  ^^  ^^'^''^'^  ^  approximate 

JaniiaryJ^J921 

""  To-Sy  '^'''''  «-**  Power  Co.  5's-1922,      $2,000.00 

Bond  Discount— C.  C.  L.  H.  &  P.  Co.  5's 
To  record  purchase  of  bond. 

JulyJ^J921 

Ca^h,  ^^^ 

To — Bond  Income, 

To  record  income  received. 

(3) 
Bond  Discount— C.  C.  L.  H.  &  P.  Co.  S's, 
To — Bond  Income, 

To  record  accumulation  for  period. 

January  1,  1922 

w 


$1,925.00 
75.00 


$50.00 


$50.00 


$25.00 


$25.00 


Cash, 
To — Bond  Income, 

To — Bond  Income, 


Cash, 

To — Bond  Income, 


$50.00 


(5) 

Jul.yJ^1922 

(6) 

(7) 
Bond  Discount— C.  C.  L.  H.  &  P.  5's, 

To — Bond  Income, 

Date 

Cash,  ^^^ 

To-CIair  Co.  Light,  Heat  &  Power  Co.  5's, 


$50.00 
$25.00 


$50.00 


$25.00 


$50.00 


$25.00 


$2,000.00 


12,000.00 


i 


CHAPTER  VII 

DEPRECIATION;    RESERVES    AND    RESERVE 
FUNDS;  SURPLUS  AND  DIVIDENDS 

PART  1.— DEPRECIATION 

Introduction. — Depreciation  is  an  importiint  subject.  Also, 
it  is  too  comprehensive  for  adequate  treatment  in  a  portion  of 
but  one  chapter.  Yet  from  the  standpoint  of  an  accounting  text, 
a  discussion  of  the  subject  ought  not  to  require  more  than  hav- 
ing one's  attention  called  to  certain  of  its  leading  features,  and 
outlining  some  of  the  methods  of  recognizing  or  determining 
depreciation.  It  should  be  recognized  that  an  accountant,  as  an 
accountant,  is  not  an  engineer;  likewise,  neither  is  he  an  expert 
appraiser. 

Depreciation  is  an  old  question,  but  of  paramount  present 
interest.    This  interest  seems  to  be  due  to  two  things: 

1.  Certain  economic  changes  in  industrial  and  commercial 
life.    . 

a.  Investors  are  more  careful  than  formerly  in  scanning 
the  conditions  of  enterprises  in  which  they  are  interested. 
When  a  plant  is  small  and  owned  chiefly  by  the  operators 
themselves,  no  one  but  the  owner  need  be  interested  in 
how  depreciation  is  provided  or  the  capital  kept  up. 
When  a  plant  increases  in  size,  and  along  with  such  in- 
crease there  comes  radical  changes  in  ownership,  the 
question  of  depreciation  takes  on  a  new  importance. 
Stocks  and  bonds  are  widely  held,  and  the  holders,  many 
being  located  far  from  the  properties  in  which  they  are 
interested,  want  to  know  how  the  property  behind  these 
securities  is  kept  up;  they  demand  information  con- 
cerning the  adequacy  of  depreciation  provisions. 

b.  A  realization  on  the  part  of  those  intimately  connect^ed 
with  an  undertaking  involving  the  use  of  fixed  assets 

212 


DEPRECIATION;  RESERVES  AND  RESERVE  FUNDS     213 

that  a  means  must  be  provided  by  which  their  property 
may  be  renewed  when  it  has  to  be  discarded.    A  correct 
treatment  of  depreciation  permits  them  to  place  the 
burden  where   it  properly   belongs, 
c.  A  realization  on  the  part  of  those  intimately  connected 
with  an  undertaking  that  net  profits  or  earnings  are  not 
true  if  depreciation  either  be  omitted  from  or  understated 
in  the  operating  expenses. 
2.  Governmental  action.    The  national  and  state  governments 
in  extending  their  activities  are  exercising  a  closer  super- 
vision over  commercial  enterprises  and  levying  heavy  taxes 
on   incomes    and    net   earnings.      In   order   that   business 
activities  may  be  effectively  as  well  as  fairly  carried  out,  all 
possible  operating  expenses  must  be  deducted  from  earnings 
before  profits  are  stated;  otherwise,  the  taxes,  sufficiently 
onerous  at  best,  will  prove  excruciatingly  burdensome  if 
not  actually  prohibitive. 
Again,  depreciation  is  important  for  reasons  other  than  those 
given  above.    These  relate  to  determining  the  present  val- 
uation of  the  physical  properties  of  an  enterprise  for  such 
purposes  as: 

1.  Purchase  and  sale. 

2.  Capitalization. 
,  3.  Rate  making. 

4.  Etc. 

Underlying  Principle.— No  capital  asset  employed  in  any 
business,  with  the  possible  exception  of  land,  remains  in  its  orig- 
inal condition  once  it  is  begun  to  be  used.  General  decay  or 
deterioration  commences  as  soon  as  an  asset  is  placed  in  opera- 
tion and  goes  on  until,  eventually,  the  usefulness  of  the  asset  is 
ended  and  its  value  is  entirely  gone  or  so  nearly  gone  that  noth- 
mg  remains  but  scrap  value.  Wooden  parts  are  certain  to  rot 
and  decay ;  iron  rusts,  wears,  and  wastes  away.  Little  or  noth- 
ing about  any  plant,  except  perhaps  land,  will  do  other  than  at 
some  time,  sooner  or  later,  reach  such  a  state  of  decrepitude 
that  it  no  longer  pays  to  repair  and  keep  it  in  use. 

Unless  this  condition  is  realized,  and  provision  made  to  re- 
place the  asset  by  a  gradual  charge  against  profits  during  the 
life  of  the  asset,  eventually  the  profits  of  one  certain  year  will 


214 


ADVANCED  ACCOUNTING 


be  required  to  replace  the  asset.  This  means  that  one  particular 
year  must  stand  the  expense  which,  rightly,  in  part  belongs  to 
past  years;  in  turn,  this  means  that  these  past  years  will  have 
shown  a  greater  profit  than  really  was  earned  therein.  Further, 
if  this  profit  has  been  paid  out  as  dividends,  the  year  in  which 
the  replacements  must  be  made  may  find  the  enterprise  in  such 
a  depleted  condition  that  there  are  not  suflScient  profits  on  hand 
against  which  the  replacements  may  be  charged.  Again,  at  this 
point,  the  result  will  be: 

1.  A  reduction  in  capital,  or 

2.  A  fictitious  charge  against  an  asset  account.  In  fact,  both 
possibilities  represent  a  capital  reduction  although  the  first 
is  apparent,  whereas,  the  second  may  not  be  noticed  except 
from  an  examination  of  the  records. 

Land  not  subject  to  depreciation,  represents  only  land  not 
directly  used  in  producing  revenue.  Land  which  is  used  directly 
in  producing  revenue  is  subject  either  to  depreciation  as  usually 
understood  or  to  depreciation  which  represents  a  wasting  away. 

a.  Farm  land.  Land  planted  with  crops  may  depreciate 
to  a  marked  degree,  and  will  actually  depreciate  unless 
scientific  farming  methods  are  used. 

b.  Clay  bed.  A  clay  bed  in  connection  with  a  brick  yard 
will  waste  away  in  direct  proportion  to  the  amount  of 
product  produced. 

Depreciation  Defined.— The  Century-  Dictionary  defines 
depreciation  as: 

1.  The  act  of  lessening  and  bringing  down  value. 

2.  A  fall  in  value ;  reduction  in  worth. 

It  is  one  of  the  unalterable  laws  of  nature  that  all  material 
things  disintegrate,  i.  e.,  wear  out.  Any  kind  of  property  will 
lose  its  usefulness  as  time  passes. 

When  an  accountant  speaks  of  "depreciation,"  however,  the 
term  should  be  applied  more  particularly  to  the  gradual  diminu- 
tion in  value  and  utility  of  capital  assets  of  a  perishable  nature 
rather  than  to  assets  of  any  other  type.  Illustrations  of  perish- 
able capital  assets  are:  buildings,  machinery,  other  equipment, 
and  tools. 

Significant  as  these  ideas  may  be  to  one  who  is  in  contact 


DEPRECIATION;  RESERVES  AND  RESERVE  FUNDS     215 

with  actual  operating  conditions  within  a  plant,  they  hardly 
convey  to  one's  mind  everything  that  is  implied  by  the  term 
"depreciation"  unless  operating  conditions  actually  have  been 
part  of  one's  experience. 

Buildings  deteriorate  or,  in  time,  become  hopelessly  out  of 
date;  machinery  is  subject  to  depreciation  and,  although  heavy 
repairs  may  prolong  or  extend  its  life,  sooner  or  later  it  must  be 
discarded.  As  soon  as  any  equipment  has  been  placed  in  position 
and  the  plant  put  in  operation,  the  value  of  the  equipment  be- 
gins to  drop  off.  Sooner  or  later,  buildings,  machinery,  and  other 
equipment,  being  subject  to  the  ravages  of  time,  will  become 
useless  from  wear  and  tear  and  from  general  decay.  New  inven- 
tions, unexpected  developments,  and  business  growth  may  re- 
quire that  present  equipment  be  replaced  by  better,  more  effi- 
cient, or  more  powerful  units,  long  before  it  is  worn  out.  Even 
though  some  parts  show  greater  resisting  power,  and  will  serve 
their  purpose  longer  than  others, — and  even  though  heavy  re- 
pairs and  careful  usage  may  prolong  or  extend  the  useful  life  of 
many  of  these  parts, — their  ultimate  fate  cannot  be  prevented; 
sooner  or  later  they  will  reach  the  junk  pile.  One  manufactur- 
ing concern  calls  its  scrap  heap  the  "graveyard." 

Fluctuation. — Certain  fundamental  differences  exist  between 
fluctuation  and  depreciation.  These  may  be  set  out  about  as 
follows : 

1.  A  capital  asset  may  fluctuate  in  market  value.  Ordinarily, 
such  fluctuation  has  no  place  upon  the  books  of  account, 
because  outside  causes  are  responsible  therefor,  rather  than 
the  operation  of  the  business.  On  the  other  hand,  deprecia- 
tion is  due  to  inside  causes  incident  to  use,  and  must  be 
booked  as  part  of  operation  expenses. 

2.  Depreciation  is  a  lessening  in  property  values,  which  is  in- 
evitable, operating  only  to  lessen  values,  whereas,  fluctua- 
tion may  increase  values  as  well  as  lessen  them. 

3.  Since  fluctuation,  in  general,  has  no  place  upon  the  books 
.of  account,  it  is  not  to  be  taken  into  consideration  when 

calculating  profits  for  a  period  of  time ;  depreciation,  on  the 
other  hand,  must  be  taken  into  consideration  when  de- 
termining profits. 
The  question  of  recording  a  fluctuation  upon  the  books  of  ac- 


; 


216 


ADVANCED  ACCOUNTING 


count  and  including  its  amount  upon  the  Balance  Sheet,  depends 
upon  two  factors: 

1.  Character. 

2.  Permanency. 

If  the  value  of  a  fixed  asset  goes  up,  the  increase  should 
not  be  written  up  by  a  charge  to  the  asset  account  and  a 
credit  to  Surplus  account  inasmuch  as  the  increase  may  not 
be  permanent;  again,  the  business  cannot  be  considered  as 
receiving  a  benefit  from  such  use  unless  the  asset  in  ques- 
tion can  be  sold.     Likewise,  a  downward  fluctuation  in  a 
capital  asset  need  not  be  considered  unless  the  drop  appears 
to  be  permanent  and,  eventually,  causes   a   serious   loss. 
This  would  apply  specifically  to  land,  because  even  though 
other  fixed  assets  may  be  replaced  at  a  figure  different  from 
their  carried  charge,  their  efficiency   in   operation  is  not 
affected,  hence,  a  sufficient  depreciation  charge  periodically 
is  all  that  is  necessary. 
Appreciation. — Some   maintain   that  the   depreciation   of   a 
plant  may  be  offset  by  the  increase  in  the  value  of  plant  land. 
This  cannot  be  unless  the  land  is  sold;  but  since  plant  land  is  a 
capital  asset  essential  in  conducting  the  business,  one  may  pre- 
sume that  it  will  not  be  sold  unless  the  business  is  sold  with  it. 
Naturally,  therefore,  a  favorable  fluctuation  in  land  value  never 
may  be  realized.    The  result  is  that,  in  applying  this  principle, 
one  is  offsetting  an  actual  realized  loss   (depreciation)   against 
an  appreciation  that  is  unrealized;  and,  following  this  to  its 
conclusion,  it  would  be  necessary  when  a  machine  is  worn  out 
to  sell  some  land  in  order  to  secure  the  funds  to  replace  it.    If 
for  no  other  reason,  than  impracticability,  the  application  of 
this  principle  is  impossible. 

Maintenance. — ^Wear  and  tear,  or  minor  renewals  ordinarily 
are  made  up  of  repairing  and  replacing  minor  equipment  as  well 
as  the  smaller  parts  of  the  larger  units  of  equipment  as  these 
wear  out,  break,  or  are  lost.  Examples  of  such  repairs  and  re- 
newals may  be  found  in  the  wearing  out  of  bearings  on  machines, 
wheels  on  cars,  shoes  on  horses,  commutators  on  dynamos. 

These  repairs  are  almost  constantly  going  on  in  an  operat- 
ing plant  and  the  expenses  involved  are  fairly  regular.  Since 
these  expenses  are  about  the  same  from  year  to  year,  they  can 


DEPRECIATION;  RESERVES  AND  RESERVE  FUNDS      217 

be  charged  directly  into  the  operating  expenses  without  causing 
serious  fluctuations  in  net  earnings.  While  expenses  of  this  kind 
are  in  the  nature  of  depreciation  they  are,  as  a  rule,  not  in- 
cluded in  depreciation  allowances  but  charged  separately  into 
the  operating  expenses. 

Causes  of  Depreciation.— An  asset  may  depreciate  because 
of  one  or  more  of  the  following  causes: 
1.  Causes  certain: 

a.  Use  in  trading  or  manufacturing.  The  constant  use  of 
an  asset  will  wear  it  out  in  time.  Even  when  this  wear- 
ing away  does  not  commence  immediately,  as  where  a 
new  machine  will  not  run  at  its  best  until  the  stiffness 
IS  eliminated,  depreciation  should  be  taken  up  as  from 
the  moment  the  machine  begins  to  produce;  at  that 
moment,  it  commences  to  earn  a  profit,  and  depreciation 
should  be  charged  as  part  of  the  cost  thereof. 

b.  Deterioration  due  to  lapse  of  time.  Even  when  a  ma- 
chine is  idle,  depreciation  continues;  in  fact,  one  may 
find  that  a  certain  machine  will  depreciate  faster  when 
idle  than  when  in  operation. 

2.  Causes  Uncertain  (contingent) : 

a.  Obsolescence.  Ofttimes  an  asset  may  be  practically  new, 
and  yet  become  almost  useless  by  being  superseded^^either 
by  improvements  or  by  newer  inventions  which  are  more 
economical  and  more  effective  generally.  Again,  spe- 
cial machinery  placed  in  use  to  manufacture  in  accord 
with  a  current  fad  may  be  useless  as  soon  as  the  fad  has 
ceased.  In  the  latter  event,  if  the  machinery  is  not 
usable  for  other  purposes,  its  whole  value  must  be 
charged  to  the  cost  of  the  goods  manufactured  during 
the  time  the  fad  is  in  existence. 

b.  Inadequacy.  An  asset  may  be  in  good  condition  and 
yet  be  discarded  for  a  better  one,  because  of  unexpected 
developments  and  growth  in  business.  If  a  utility  com- 
pany expands  its  field  of  operations,  it  may  require  new 
boilers,  etc.,  more  powerful  than  those  now  in  use  In- 
adequacy  may  occur  even  where  the  original  design  and 
installation  were  of  the  best. 


218 


ADVANCED  ACCOUNTING 


c.  Accident.  Some  concerns  may  be  liable  to  severe  and 
costly  accidents;  in  fact,  any  business  may  suffer  a 
severe  loss  as  the  result  of  an  accident,  as  from  explosion, 
a  flood,  wind,  electrolysis,  etc.  A  contingency  exists  here 
against  which  provision  should  be  made  in  advance  by 
an  average  annual  charge  against  profits  rather  than 
wait  until  the  accident  occurs  and  have  the  entire  cost 

•  applied  against  one  particular  year.  As  far  as  possible, 
accidents  should  be  provided  against  by  proper  insur- 
ance which  in  some  cases  may  be  carried  by  the  concern 
itself  rather  than  by  a  regular  insurance  company. 

Contingent  Losses  as  Depreciation. — The  separation  made 
in  the  last  section  between  causes  certain  and  causes  uncertain 
differentiates  between  what  might  be  considered  as  true  deprecia- 
tion and  questionable  depreciation.  Further,  this  separation  fol- 
lows the  accounting  treatment  accorded  each  class: 

1.  Causes  certain.  Depreciation  hereunder  is  a  cost  of  doing 
business  represented  by  a  charge  to  a  Depreciation  account 
and  a  credit  to  a  Reserve  for  Depreciation  account.  The 
latter  account  is  a  valuation  account  appearing  on  the  left 
side  of  the  Balance  Sheet  as  a  deduction  from  the  cost  of 
the  asset  affected. 

2.  Causes  uncertain.  Although  the  possibility  of  loss  of  value 
from  obsolescence,  inadequacy,  and  accident  must  be 
guarded  against,  the  provision  therefor,  ordinarily,  is  rep- 
resented by  a  charge  to  Surplus  account  and  a  credit  to  a 
Reserve  for  Contingencies  account.  In  other  words,  pro- 
vision for  loss  is  made  by  means  of  a  true  reserve  account,— 
appropriated  surplus,— the  balance  of  which  will  be  shown 
as  an  item  upon  the  right  side  of  the  Balance  Sheet  under 
the  section  of  "Appropriated  Surplus." 

Depreciation  an  Operating  Expense— A  Manufacturing 
Cost.— Depreciation  is  a  charge  against  revenue;  it  is  an  integral 
part  of  the  cost  of  production  or  operating  expense.  It  is  as 
much  a  part  of  manufacturing  cost  as  materials  and  labor,  even 
though  the  accounting  involved  relates  to  the  ascertainment  of 
the  diminishing  value  of  each  piece  of  capital  asset  for  which 
value  has  been  given,  rather  than  to  the  determination  of  an 


DEPRECIATION;  RESERVES  AND  RESERVE  FUNDS     219 

immediate  lump  sum  amount  representing  material  or  labor  used 
daily. 

For  example,  one  may  conceive  of  three  piles  standing  side  by 
side.  One  represents  labor  cost,  one  material,  and  one  ma- 
chinery. If  a  long  enough  period  of  time  be  taken,  it  will  be 
seen  that  all  three  piles  are  consumed.  Assume,  for  example 
a  machme  as  representing  the  third  pile  which  has  a  usable  life 
of  ten  years,  and  that  the  other  piles  represent  consumption  of 
material  and  labor  for  the  same  length  of  time.  Assume  further 
that  a  Statement  of  Profit  and  Loss  is  prepared  at  the  end  of 
the  tenth  year,  not  before. 

It  does  not  seem  difficult  to  observe  that  ^t  the  end  of  the 
tenth  year,  all  three  piles  will  be  consumed.  Hence,  if  one 
pile  labor,  represents  a  cost,  it  seems  logical  to  assume  the 
third  pile,  machmery,  now  consumed,  is  a  cost  as  well  It  is 
only  when  this  ten-year  period  is  divided  into  smaller  periods 
as  yearly  periods,  that  the  speed  of  consumption  of  labor  and 
material  appears  so  rapid,  whereas,  the  consumption  of  the  ma- 
chme  appears  as  nothing.  Since  the  depreciation  of  the  ma- 
chine IS  caused  directly  by  the  manufacturing  processes,  it  is  as 
much  a  naanufacturing  cost  as  the  material  or  labor  used  di- 
rectly  m  fabricating  an  article. 

Factors  Considered  in  Determining  Depreciation  Amount. 

Ihe  prmcipal  factors  by  means  of  which  the  amount  of  depre- 
ciation may  be  determined  are  about  as  follows: 

1.  Original  cost.  This  includes  aU  cost  elements  up  to  the 
point  where  the  asset  is  ready  to  produce;  it  is  the  value 
to  be  written  out  (exclusive  of  scrap  value)  as  part  of  the 
operation  expenses  period  by  period.  Hence,  original  cost 
IS  the  basis  upon  which  all  calculations  must  rest. 

2.  Scrap  value,  or  minimum  service  value.  The  greater  the 
salvage  upon  a  piece  of  equipment  that  is  no  longer  usable, 
the  less  wiU  be  the  periodical  amount  to  be  written  off  as 
depreciation.  This  value  depends  largely  upon  whether 
the  parts  or  units  can  be  fixed  up  and  used  again,  or  whether 
they  must  be  treated  as  junk;  in  the  first  instance,  the 
value  may  be  considerable,  whereas,  in  the  latter,  it  may 
be  practically  nothing.     Scrap  value,  when  found,  would 


220 


ADVANCED  ACCOUNTING 


1. 

•  • 

u. 

•  •  • 

111. 


be  deducted  from  the  cost  new  when  assigning  the  life  for 
depreciation  purposes. 
3.  Probable  life  of  the  property  involved.  Perhaps  the  most 
compHcated  and  difficult  portion  of  the  real  work  in  con- 
nection with  depreciation  consists  in  estimating  the  prob- 
able life  of  the  asset  to  be  depreciated.  The  original  value 
or  purchase  cost  of  an  asset  is  determined  readily,  and  its 
scrap  value  may  be  calculated  fairly  accurately  without 
much  trouble;  but  the  probable  life  of  an  asset  is  difficult 
to  estimate,  inasmuch  as  it  is  dependent  upon  many  varied 
elements: 

a.  Character  of  the  asset 

b.  Local  conditions 
Use  to  which  asset  is  put 
Surroundings 

Plant  management.  An  overworked  machine  will 
depreciate  faster  than  one  not  overworked.  An 
asset  that  is  kept  up  to  a  high  standard  of  efficiency 
by  having  repairs  made  thereon  constantly,  will 
last  longer  than  if  it  were  allowed  to  fall  into  a 
dilapidated  condition.  Property  when  used  for  the 
purposes  for  which  intended  will  last  longer  than 
when  shifted  from  place  to  place. 
Installation.  High  grade  construction  will  last 
longer  than  poor  grade.  Provision  in  the  original 
instance  to  meet  future  possible  conditions  likely  to 
materialize  within  a  reasonable  time  will  cause  an 
asset  to  have  more  years  of  life  than  otherwise. 

V.  Line  of  work 

Climatic  conditions.  Excessive  heat  and  humidity, 
and  extremely  cold  weather  are  all  apt  to  affect 
Seriously  the  hfe  of  certain  classes  of  property. 
Employees.  A  careful  operator  will  prolong  the 
life  of  a  machine,  whereas  a  careless  or  incompetent 
employee  will  reduce  what  might  be  considered  the 
average  Ufe  of  a  machine. 

Sales  value.  Some  assets  depreciate  rapidly  at 
first  and  then  more  slowly  later  on,  especially  when 
sales  value  is  considered;  equipment  will  become 
second-hand  almost  as  soon  as  placed  in  operation 


IV. 


VI. 


vu. 


Vlll. 


DEPRECIATION;  RESERVES  AND  RESERVE  FUNDS      221 

and,  if  it  has  to  be  sold,  then  it  will  bring  only 
second-hand  prices. 
ix.  Service  value.  When  service  value  is  considered 
rather  than  sales  value,  equipment  will  depreciate 
slowly  at  first  and  faster  later  on,  the  increase  at 
times  not  being  noticeable  until  just  before  the  end 
of  life. 

All  these  factors,  and  others,  have  a  bearing  upon  the  probable 
Me  of  an  asset;  but  only  experience  will  enable  one  to  determine 
how  long  an  asset  may  be  expected  to  last.  Yet  from  the  stand- 
point of  an  accountant,  the  matters  pertaining  to  determining 
the  probable  life  of  an  asset  relate  to  the  work  of  an  engineer, 
not  to  that  of  an  accountant.  It  is  the  engineer's  estimate  of 
the  life  of  an  asset  upon  which  the  accountant  must  depend,  or, 
at  least,  should  depend. 

When  the  accountant  has  secured  this  figure,  and  knowing 
the  original  value,  the  probable  residual  value,  and  the  specific 
case  m  hand,  it  is  his  duty  to  form  an  accurate  opinion  as  to 
what  should  be  considered  a  reasonable  yearly  depreciation 
by  means  of  one  of  the  several  methods  used  in  determining 
depreciation  rates.  If  the  amount  being  charged  off  appears  too 
small.  It  is  the  accountant's  duty  to  give  warning  that  future 
disaster  is  being  courted. 

Again,  in  certain  cases,  as  in  general  practice,  the  accountant 
may  be  required  by  concerns  which  cannot  afford  engineering 
services,  particularly  small  enterprises,  to  cover  all  the  angles 
of  the  problem  mentioned  above.  Hence,  his  knowledge  of  the 
subject  should  be  considerable,  although  he  should  not  forget 
that,  in  solving  a  problem  in  its  entirety,  he  is  doing  so  as  an 
accountant;  in  such  case,  if  his  results  are  reasonable  and  con- 
servative, his  efforts  cannot  well  be  criticized. 

Method  of  Determining  Depreciation  Charges.— The  per-, 
lodical  depreciation  charge  may  be  computed  by  any  one  of 
numerous  methods,  some  apparently  worth  while  and  others 
apparently  more  theoretical  than  practical.  It  does  not  seem 
to  be  withm  the  province  of  an  accountant  to  assume  an  expert 
knowledge  of  the  practicability  of  any  one  method  as  agahist 
another.  .  =" 

Although  an  accountant  is  not  an  expert  valuer  of  fixed  assets, 


222 


ADVANCED  ACCOUNTING 


to  the  end  that  he  will  specify  the  amount  of  depreciation  to  be 
allowed  in  a  specific  case,  he  should  be  so  well  acquainted  with 
the  general  principles  of  the  subject  and  with  the  general  working 
of  the  more  usual  methods  of  rate  determination  that  he  can 
form  an  accurate  opinion  as  to  what  is  reasonable. 

The  various  methods  used  in  determining  the  depreciation 
charge  may  be  set  down  about  as  under: 

1.  Straight  line  (fixed  or  equal  proportion). 

2.  Fixed  percentage  on  diminishing  value  (reducing  balance). 

3.  Sum  of  the  year  digit  (changing  percentage  or  fraction). 
^     4.  Sinking  fund. 

5.  Annuity. 

6.  Revaluation  (appraisal). 

7.  Composite  life. 

8.  Working  hours. 

9.  Production  or  output. 
10.  Miscellaneous. 

Each  of  the  above  will  be  considered  briefly  in  subsequent 
sections. 

Straight  Line  Method.— This  is  the  most  common  method  of 
writing  off  depreciation,  being  the  simplest  and  most  direct  of 
any.  It  is  advocated  by  the  Interstate  Commerce  Commission, 
and  for  certain  purposes  by  many  of  the  state  commissions.  It 
derives  its  name  from  the  fact  that  a  graphic  chart  of  the  depre- 
ciated value  of  the  asset  year  by  year  will  show  a  plotted  straight 
oblique  line  with  a  vertical  drop  at  the  end.  Hereunder,  an 
equal  proportion  of  cost  is  written  off  each  year.  In  formula 
form,  the  method  may  be  indicated  as  follows: 

Depreciation  (D)  =  Cost  (C)  ~  Scrap JS) 

No.  of  years (N) 

This  method  is  objected  to  on  the  ground  that  it  does  not  do 
what  it  is  designed  to  do,— spread  the  exact  burden  in  an  equi- 
table manner  over  the  periods  at  the  end  of  each  of  which  net 
profit  is  determined.  A  new  machine  requires  but  little  in  the 
way  of  repair  and  maintenance  expenditure,  whereas  in  the  latter 
years  of  its  life  this  expenditure  will  be  heavy.  The  amount 
which  must  be  spread  evenly  over  the  life  of  the  machine  is  the 
sum  of  the  depreciation  charge  plus  the  upkeep  charge;  in  the 
latter  years,  this  sum  will  increase  faster  than  in  the  early  years 


DEPRECIATION;  RESERVES  AND  RESERVE  FUNDS      223 

whereas  the  "straight  line"  method  will  not,  in  its  working,  cpn- 
form  thereto. 

Where  this  method  provides  for  charging  all  extraordinary  or 
intermittent  renewals  against  a  depreciation  fund  (see  next  sec- 
tion beyond),  the  method  seems  to  be  greatly  in  favor  among 
many  large  corporations.  And  the  opinion  is  ventured  that  over 
a  long  period  of  time,  this  plan  actually  does  work  equitably  in 
distributing  depreciation  over  the  life  of  the  asset. 

Fixed  Percentage  on  Diminishing  Value  Method.— In 
order  to  overcome  the  objection  which  is  raised  to  the  straight 
line  method,  this  method  often  is  used.  Hereunder,  the  depre- 
ciation burden  is  reduced  year  by  year,  as  the  net  carrying  value 
of  the  asset  is  decreased.  Theoretically,  at  least,  this  method 
seems  to  be  a  just  one,  inasmuch  as  by  its  use  the  depreciation 
charge  is  large  when  repairs  are  small,  and  decreases  as  the  repair 
charges  increase;  by  its  use,  the  burden  is  distributed  equitably 
over  all  the  years  of  the  life  of  the  asset. 

This  method  contemplates  determining  a  uniform  percentage 
rate  which,  when  calculated  each  year  on  the  diminishing  bal- 
ance, will  reduce  the  asset  to  scrap  within  the  prescribed  number 
of  years.  The  formula  for  obtaining  the  required  percentage  rate 
is  rather  complicated,  involving  the  use  of  logarithms.  It  is  about 
as  follows: 


Percentage  ( P)  =1    -    /Scrap  (S) 

y  Cost  (c) 

n,  the  number  of  periods. 

To  illustrate  the  use  of  this  formula  in  determining  the 
percentage  rate,  consider  a  machine  with  a  present  value  of 
$47,000.00,  estimated  to  last  ten  years,  with  a  scrap  value  of 
$2,000.00.  Substituting  these  values  in  the  above  equation,  the 
following  results: 


10/ 

Percentage  (P)  =  I  —  ^ 

1' 


2,000 


47,000 

And  by  solving  this  equation  with  the  use  of  logarithms,  the 
following  results: 

c)      =  ^^g-  (4^;       =  1/10  (3.3010  -  4.6721) 

=  1.86289  =  1  -  .729  =  .271 
Hence,  the  rate  to  use  is  27.1  per  cent. 


224 


ADVANCED  ACCOUNTING 


In  applying  this  percentage  rate,  a  zero  valuation  never  can 
be  secured,  inasmuch  as  the  series  becomes  indefinite  and  inde- 
terminate. 

This  method  is  advocated  by  many  accountants,  and  has 
features  worthy  of  commendation. 

Depreciation  Fund. — It  happens  at  times  that  the  manage- 
ment of  a  business  wants  to  set  aside  a  cash  fund  for  depreciation 
so  that  as  parts  of  the  plant  wear  out  the  money  will  be  on  hand 
to  replace  them.  Under  this  plan,  the  fund  will  be  equal  in 
amount  to.  and  offset,  the  Reserve  for  Depreciation  account. 

The  cash  in  this  fund  may  be  placed  in  investments  which  will 
be  carried  in  the  fund.  If  so,  it  is  usual  to  credit  all  income 
from  such  investments  to  a  general  miscellaneous  income  ac- 
count; it  is  said  that  depreciation  goes  on  whether  investments 
pay  or  do  not  pay,  and  hence  investment  income  should  not 
be  confused  with  depreciation,  but  should  be  credited  to  a  general 
income  account. 

Sum  of  the  Year  Digit  Method. — Since  the  fixed  percentage 
on  diminishing  value  method  makes  use  of  a  formula  in  deter- 
mining the  percentage  rate  to  use  thereunder  that  is  somewhat 
difficult  to  apply,  a  substitute  method  often  is  used  which  gives 
fairly  good  results.  The  application  of  this  method  is  best  dis- 
cussed by  applying  it  to  an  example. 

Assume  the  same  conditions  as  were  indicated  in  the  problem 
above.  Since  the  estimated  life  is  ten  years,  the  following  is 
done  first:  Add  together  the  digits  1,  2,  3,  4,  5,  6,  7,  8,  9,  10.  The 
sum  secured  is  55.  This  55  is  then  taken  as  the  denominator  of 
a  fraction  which  reduces  in  size  each  year,  and  by  means  of  which 
the  yearly  depreciation  is  calculated.  At  the  end  of  the  first 
year,  10/55  of  $45,000.00  will  be  charged  off;  at  the  end  of  the 
second  year.  9/55,  and  so  on,  until  the  last  year,  when  the  depre- 
ciation charge  will  be  only  1/55. 

Sinking  Fund  Method. — One  method  of  handling  deprecia- 
tion is  to  set  aside  annually  a  sum  which,  at  compound  interest, 
will  be  sufficient  to  replace  a  plant  when  it  has  to  be  renewed. 
This  plan  is  known  as  the  "sinking  fund"  plan,  although,  as  will 
be  seen  in  a  later  chapter,  the  title  does  not  seem  exactly  correct, 
inasmuch  as  a  sinking  fund  should  relate  to  a  method  of  periodi- 
cally providing  a  sum  which,  at  compound  interest,  will  pay  off 


DEPRECIATION;  RESERVES  AND  RESERVE  FUNDS      225 

an  existing  obligation  when  the  latter  matures ;  the  sinking-fund 
principle  is  made  use  of,  but  that  is  all. 

The  annual  charge  to  the  Profit  and  Loss  account  will  be  the 
amount  invested  each  year  plus  the  interest  charged  to  the  so- 
called  sinking  fund  that  year.  This  method  is  a  most  conserva- 
tive one  in  that  thereunder  when  the  property  becomes  worn 
out,  sufficient  cash  will  be  on  hand  to  replace  it.  Three  serious 
objections  seem  present  against  using  this  method,  even  though 
it  is  used  considerably.    These  may  be  stated  as  follows: 

1.  In  general,  the  amount  of  cash  deposited  each  year  in  the 
fund  will  not  earn  as  much  interest  as  the  same  amount 
invested  in  the  business. 

2.  The  depreciation  burden  becomes  heavier  as  the  asset  ap- 
proaches the  end  of  its  useful  life.  This  objection  is  similar 
to  the  one  raised  in  connection  with  the  straight  line  method. 

3.  In  general,  this  method  does  not  seem  to  be  a  practical  one 
unless  elaborate  records  of  properties  are  kept,  and  but  few 
companies  are  willing  to  incur  the  expense  necessary  to 
keeping  such  records. 

A  discussion  relative  to  calculating  the  annual  charge  to  the 
sinking  fund  will  not  be  included  herein  since,  of  necessity,  it 
would  be  similar  to  that  necessary  in  discussing  the  calculation 
of  the  annual  charge  to  a  bond  sinking  fund.  The  latter  will 
be  taken  up  in  the  next  chapter,  and  the  discussion  of  sinking 
fund  calculations  seems  more  important  in  connection  therewith 
than  hereunder.  ^ 

Annuity  Method. — This  method  is  based  upon  the  assump- 
tion or  theory  that  the  cost  of  production  should  include  interest 
upon  the  capital  invested  in  the  fixed  asset  as  well  as  the  usual 
items  of  repairs,  maintenance,  and  depreciation.  Hereunder,  de- 
preciation should  be  a  "sum  figured  as  a  constant  annual  charge, 
sufficient  not  only  to  write  off  the  decline  in  value,  but  also  to 
write  off  annual  interest  charges  on  (the)  diminishing  value." 

The  method  does  not  seem  to  have  the  approval  of  the  best 
authorities.  Interest  upon  capital  is  not  universally  accepted 
as  part  of  production  cost.  Again,  it  may  be  said  to  be  artifi- 
cial, and  open,  also,  to  an  objection  already  advanced  in  another 
connection  that  the  greatest  amount  will  be  charged  off  during 
the  later  years  of  the  life  of  an  asset  than  during  the  beginning 


226 


ADVANCED  ACCOUNTING 


'ti 


> 


years.  Further,  the  formula  to  be  used  in  making  the  calculation 
is  more  or  less  involved;  the  method  would  seem  to  be  one  to 
be  favored  by  a  theoretical  mathematician,  not  by  a  practical 
man. 

Revaluation  Method.— This  method  of  dealing  with  depre- 
ciation contemplates  a  revaluation  or  appraisal  of  the  assets  at 
the  end  of  each  accounting  period,  as  yearly.  Hereunder,  the 
difference  between  the  book  value  at  the  end  of  the  year  and  the 
value  disclosed  by  the  appraisal  would  be  written  off  as  depre- 
ciation against  the  operations  of  the  year. 

In  general,  the  method  is  not  a  practical  one  for  two  reasons: 

1.  Elaborate  property  records  are  necessary  and  but  few  con- 
cerns are  willing  to  incur  the  expense  necessary  to  keep  such 
records. 

2.  It  does  not  result  in  spreading  the  depreciation  scientifically 
over  the  various  accounting  periods  (see  qualification  in 
next  paragraph). 

So  far  as  small  tools  and  office  furniture  and  fixtures  are  con- 
cerned, this  method  seems  the  most  desirable  of  all,  as  concerns 
these  items,  since  it  tends  to  distribute  equitably  the  loss  in  value 
or  depreciation  against  each  year's  operations. 

Composite  Life  Methods. — In  public  utility  accounting,  a 
composite  life  method  is  used  commonly.  In  the  first  instance, 
in  public  utility  accounting,  the  composite  life  of  the  plant  as  a 
whole  is  determined.  Next,  the  annual  depreciation  charge  is 
calculated  so  that  at  the  end  of  this  life  period  the  entire  value 
of  cost  less  scrap  will  be  written  off.  The  depreciation  charge 
may  be  calculated  in  connection  with  the  composite  life  of  the 
plant  in  a  niunber  of  ways  already  discussed,  as: 

1.  Straight  line. 

2.  Diminishing  value. 

3.  Sinking  fund. 

The  property  first  is  classified  both  as  to  cost  value  less  scrap, 
and  as  to  age.  Next,  the  class  of  property  having  the  longest 
life  is  taken  as  the  basis,  and  the  number  of  renewals  of  the 
other  classes  of  property  during  that  basic  period  is  determined. 
Next,  the  total  cost  of  renewals  in  each  class  during  that  period 
is  calculated.  Next,  these  costs  are  multiplied  by  the  years  of 
life  for  each  class  and  the  product  secured  for  each  class  extended 


DEPRECIATION;  RESERVES  AND  RESERVE  FUNDS      227 

as  "dollar  years."  The  total  dollar  years  divided  by  the  total 
cost  of  all  renewals  during  the  period  gives  the  composite  life, 
or  mean  life,  of  the  plant.  A  schedule  to  use  hereunder  would  be 
headed  about  as  follows: 

Class  of  property. 

Life. 

Cost  of  reproduction  new. 

Scrap  value. 

Cost  new  less  scrap. 

Times  renewed  in  .  .  .  (base)  .  .  .  period. 

Dollars  required  in  .  .  .  (base)  .     .  period. 

Dollar  years. 

Except  for  the  matter  of  determining  the  mean  life  of  a  plant 
by  dollar  years,  this  method  will  not  differ  from  any  of  the  others. 

Working  Hours  Method.— This  method  calculates  depre- 
ciation upon  the  basis  of  the  number  of  working  hours  estimated 
as  representing  the  life  of  an  asset.  When  the  rate  per  working 
hour  has  been  obtained,  the  depreciation  for  an  accounting  period 
is  computed  by  multiplying  this  rate  by  the  total  number  of 
hours  the  asset  has  been  working  during  the  period,  the  result 
secured  being  the  total  period's  depreciation. 

This  method  seems  most  desirable  from  the  viewpoint  that  the 
charge  for  depreciation  conforms  to  the  use  of  the  asset  in  ques- 
tion, it  being  assumed  that  the  depreciation  will  be  in  proportion 
to  use.  However,  regardless  of  its  desirability,  the  objection 
may  be  made,  as  in  the  case  of  the  straight  line  method,  that 
heavy  repairs  and  upkeep  toward  the  end  of  the  asset's  life  are 
not  recognized,  inasmuch  as  the  amount  thereof  cannot  be  com- 
puted in  advance  with  any  degree  of  accuracy. 

l>roduction  or  Output  Method.— Hereunder,  the  depreciation 
rate  is  charged  per  unit  of  output.  The  method,  to  some  extent, 
resembles  the  working  hours  plan.  It  is  especially  applicable 
to  assets  of  the  nature  of  furnaces,  kilns,  etc.,  where  linings  must 
be  renewed  on  the  basis  of  actual  use. 

Again,  it  is  particularly  applicable  in  amortizing  wasting 
assets  such  as  timber  stumpage,  and  coal  or  ore  mines,  if  no 
distmction  is  to  be  made  between  the  assets  subject  to  depre- 
ciation and  those  which  are  of  the  wasting  type.  In  the  case 
of  wasting  assets,  however,  these  decreasing  in  value  in  exact 


i' 


I 


I '  i 


228 


ADVANCED  ACCOUNTING 


ratio  to  the  amounts  used,  it  is  doubtful  whether  such  decrease 
is  depreciation. 

In  the  case  of  wasting  assets,  the  charge  would  be  made  when 
a  sale  has  taken  place,  not  before.  There  is  just  as  much  on;  on 
hand,  for  example,  whether  it  is  on  the  surface  or  under  ground ; 
the  quantity  does  not  change  until  a  sale  has  taken  place. 

It  may  be  stated,  in  conclusion,  that  the  production  method 
may  be  operated  upon  a  sinking-fund  basis  rather  than  upon  the 
proportional  basis  presented  above. 

Miscellaneous  Methods.— Depreciation  methods,  other  than 
the  above,  may  be  summarized  briefly,  since  no  detailed  discus- 
sion of  any  one  seems  necessary: 

1.  Arbitrary  amounts  are  charged  periodically  to  depreciation: 

a.  Increasing  as  time  passes. 

b.  Decreasing  as  time  passes. 

2.  Arbitrary  amounts  are  written  off  at  any  convenient  time. 

3.  Unit  cost.  Each  unit  of  product  has  equalized  thereover  in 
the  periodical  depreciation  charge,  interest  on  investment, 
operation  and  repair  charges,  and  actual  depreciation.  This 
method  involves  an  elaborate  mathematical  calculation 
making  use  of  the  sinking-fund  principle. 

4.  Replacement.  Hereunder,  no  depreciation  is  booked,  all 
replacements  and  renewals  being  assumed  as  offsetting 
depreciation. 

5.  Maintenance.  Hereunder,  the  periodic  maintenance  cost  of 
an  asset  measures  the  depreciation  charge  made. 

6.  Gross  earnings.  Hereunder,  the  amount  of  the  periodical 
depreciation  charge  depends  upon  earnings.  In  lean  years, 
therefore,  the  charge  will  be  less  than  in  prosperous  years, 
since  the  rate  is  calculated  upon  earnings. 

7.  Insurance.  Hereunder,  actuarial  principles  are  used.  The 
fund  accumulated  or  measured  by  depreciation  charges  does 
not  come  into  existence  until  it  can  be  used,  and  then  it  is 
to  be  used  within  the  period  in  which  it  came  into  existence. 

8.  Fifty  per  cent.  This  method  is  usable  only  when  an  asset 
reaches  the  point,  due  to  depreciation,  where  it  must  be 
renewed.  The  theory  is  that  ordinary  repairs  will  always 
keep  an  asset  in  a  50  per  cent  condition  at  least.  Hence, 
depreciation  is  applicable  only  to  the  other  50  per  cent. 


DEPRECIATION;  RESERVES  AND  RESERVE  FUNDS      229 

Fallacy  in  Theoretical  Depreciation  Discussion.— In  the 
discussions  above,  the  assumption  has  been  made,  which  is  gen- 
eral, that  an  asset  being  depreciated  will  be  used  until  scrap  value 
is  reached;  herein  lies  the  fallacy.  As  a  matter  of  practice,  no 
asset  should  be  kept  when  its  condition  drops  below  75  to  65  per 
cent,  in  other  words,  no  asset  should  be  kept  which  has  depre- 
ciated beyond  25  to  35  per  cent.  If  so,  the  repair  and  renewal 
charges  will  be  too  heavy  for  practical  purposes,  and  a  new  asset 
should  be  secured.  Again,  regardless  of  how  much  care  is 
observed  in  calculating  a  depreciation  rate,  many  instances  will 
be  encountered  where  the  book  depreciation  to  date  will  be  far 
in  excess  of  actual  depreciation.  In  other  words,  on  the  records 
an  asset  may  be  even  down  to  scrap  value,  whereas,  as  a  matter 
of  fact,  the  asset  will  be  in  use  and  functioning  at  least  65  per 
cent;  the  deduction  to  be  drawn,  naturally,  is  that  production 
costs  in  the  past  were  excessive.  The  conclusion  to  be  drawn 
would  seem  to  be  that,  regardless  of  all  the  possible  methods  that 
may  be,  or  are,  used,  the  correct  method,  under  many  cases,  has 
not  as  yet  been  found. 

Depreciation  Rates.— In  determining  the  rate  of  depreciation 
for  a  particular  asset,  no  two  persons  would  agree.  In  the  first 
place,  each  problem  presented  contains  dissimilar  elements; 
hence,  no  specific  rules  for  specific  types  of  cases  would  seem 
applicable.  At  best,  the  amount  to  be  determined  upon  is  a 
matter  of  judgment,  tempered  by  experience.  So  long  as  the 
judgment  is  conservative,  and  so  long  as  ample  depreciation  is 
provided,  the  accountant  should  be  satisfied. 

Although  no  two  persons  will  agree  in  estimating  depreciation 
rates,  the  following  estimates  are  presented  so  that  the  student 
may  have  something  of  a  definite  nature  for  reference.  The  six 
classes  of  assets  set  out  are  the  usual  ones  concerning  which 
accountants  ordinarily  have  to  deal  in  practice: 

1.  Buildings.    From  IVg  to  5  per  cent  per  annum,  the  average 
being  about  2^/^  per  cent. 

2.  Machinery.    From  5  to  10  per  cent  per  annum. 

3.  Furniture  and  fixtures.    From  10  to  15  per  cent  per  annum. 

4.  Horses  and  wagons. 

a.  Revalue  at  end  of  each  year  and  write  off  the  difference 


I 


230 


ADVANCED  ACCOUNTING 


between  that  value  and  book  value  against  operations  of 
the  current  year, 
b.  About   10  per  cent  per   annum.     Horses,   alone,   may 
average  about  15  per  cent  per  annum. 

5.  Automobiles.    From  15  to  33V3  per  cent  per  annum. 

6.  Tools  and  running  gear. 

a.  Revalue  as  indicated  already  above. 

b.  From  20  to  331/3  per  cent  per  annum. 

Booking    Depreciation.— The    following   are    representative 
methods  of  treating  depreciation  upon  the  books  of  account: 

1.  Charge  Depreciation  account  and  credit  the  asset  accounts. 
Hereunder,  the  assets  are  written  down ;  hence,  the  cost  of 
each  written  down  asset  is  lost  sight  of.  This  is  a  serious 
objection  to  the  method  inasmuch  as: 

a.  The  cost  value  of  any  asset  should  be  its  booked  value. 

b.  The  cost  value  becomes  the  settlement  basis  with  insur- 
ance companies  in  case  of  loss. 

2.  Charge  Depreciation  account  and  credit  a  ''pool"  Deprecia- 
tion Reserve  account,  this  reserve  covering  all  classes  of 
property.  The  objections  to  this  method  are  about  as 
follows: 

a.  The  net  carrying  value  of  each  particular  class  of  fixed 
assets  cannot  be  determined  except  by  analyzing  the  ac- 
count. If  an  account  must  be  made  over  before  it  pre- 
sents an  intelligent  story,  the  account  should  have  been 
revamped  in  the  original  instance  before  entries  are 
booked. 

b.  No  means  exists  of  verifying  the  accuracy  of  the  increases 
to  the  account  inasmuch  as  actual  depreciation  for  each 
class  of  property,  from  time  to  time,  cannot  be  checked 
against  the  booked  theoretical  depreciation. 

3.  Charge  Depreciation  account  and  credit  a  specific  Depre- 
ciation Reserve  account  for  each  class  of  property.  This 
seems  to  be  the  best  method  to  adopt  inasmuch  as  the  cost 
value  of  an  asset  less  the  amount  in  the  Depreciation  Re- 
serve account  will  show  the  asset's  net  carrying  value. 
Usually,  this  method  is  the  only  one  used  in  the  elementary 
study  of  accounting  principles;  hence,  it  should  be  familiar 
to  all  advanced  students. 


DEPRECIATION;  RESERVES  AND  RESERVE  FUNDS     231 

The  Depreciation  Reserve  account  for  a  particular  class  of 
assets  would  record  the  following  elements: 

1.  Debits. 

a.  Extraordinary  or  periodical  renewals  which  tend  to  in- 
crease the  original  life  of  the  plant. 

b.  Cost  value  of  whatever  portions  of  the  asset  in  question 
are  dismantled;  the  offsetting  credit  would  be  against  the 
asset  account. 

2.  Credits. 

a.  Provision  for  the  accrued  depreciation  calculated  upon 
the  basis  of  the  annual  rates  adopted ;  the  offsetting  debit 
would  be  against  the  Depreciation  account  carried  for 
the  class  of  assets. 

b.  Scrap  value  of  whatever  portions  of  the  asset  in  question 
are  dismantled;  the  offsetting  debit  would  be  against  a 
scrap  account  representing  scrap  stock. 

3.  Balance.  Represents  depreciation  that  has  accrued  to  date 
not  yet  made  good.  ' 

The  Reserve  for  Depreciation  account  may  be  set  out  upon  the 
Balance  Sheet  in  either  of  two  ways,  dependent  upon  the  view- 
point taken  as  to  what  such  a  reserve  represents: 

1.  As  a  liability.  This  viewpoint  would  consider  the  reserve 
as  a  special  liability,  to  be  set  out  as  such,  representing  a 
provision  to  cover  a  liability  for  an  expenditure  which  must 
be  made  in  the  future  to  purchase  a  new  asset  when  the  old 
one  is  discarded.  Hereunder,  the  reserve  will  show  as  a 
liability  upon  the  Balance  Sheet. 

2.  As  a  valuation  or  estimate  account.  Hereunder,  the  reserve 
IS  an  opinion  of  some  one,  assumed  as  being  competent  of 
the  amount  that  an  asset  or  class  of  assets  has  diminished 
m  value  by  deterioration.  It  represents  merely  what  may 
be  considered  as  a  suspended  credit  to  the  asset  account 
carried  m  a  separate  account  for  reasons  already  given' 
Hereunder,  the  reserve  will  be  shown  upon  the  Balance 
Sheet  as  a  deduction  from  the  asset.  Since  depreciation 
should  represent  actual  loss  insofar  as  one  may  estimate  the 
amount  thereof,  it  seems  that  this  view  is  the  correct  one 


232 


ADVANCED  ACCOUNTING 


1. 


11. 


Replacing  or  Selling  Depreciated  Assets. — Two  more  or 
less  elementary  problems  arise  relative  to  depreciation  elements 
which  may  be  commented  upon  briefly: 

1.  Replacing  a  depreciated  asset.    This  problem  seems  to  pre- 
sent a  two-way  differentiation: 

a.  Depreciated  asset  worn  out.  Charge  the  cost  of  the  old 
asset  to  the  Depreciation  Reserve  account  carried.  If 
the  reserve  has  been  calculated  properly,  its  amount  will 
represent  the  whole  cost  of  the  asset  charged  against 
profits  and  credited  against  the  reserve. 

b.  Depreciated  asset  not  worn  out.  Sometimes  a  partially 
depreciated  asset  will  be  replaced  by  a  better  one,  the 
replacing  being  caused  by  something  that  could  not  be 
foreseen  when  the  original  asset  was  secured.  The  old 
asset's  remaining  net  value  may  be  taken  care  of: 

By  a  charge  to  Surplus  account,  provided  such 
procedure  does  not  eliminate  this  account  entirely. 
By  leaving  the  old  asset  upon  the  books  to  be 
written  off  as  rapidly  as  possible  during  subsequent 
periods  or  years,  and  by  booking  the  new  asset  in 
a  separate  account. 

2.  Selling  a  partially  depreciated  asset.    Hereunder,  a  two-way 
possibility  exists: 

a.  Sales  price  less  than  net  carrying  value.  The  difference 
between  the  cost  and  the  price  realized  consists  of  depre- 
ciation charged  off  already  and  the  profit  or  loss  from 
the  sale.  The  asset  account  should  be  credited  to  elimi- 
nate the  cost;  the  depreciation  reserve  should  be  debited 
to  eliminate  the  amount  credited  to  it  on  account  of  this 
particular  asset;  and  Surplus  account  should  be  charged 
to  take  up  the  loss  suffered.  Even  though  the  above 
really  assumes  a  sale  as  at  the  end  of  a  year  after  the 
periodical  depreciation  has  been  adjusted,  the  procedure 
followed  may  be  applied  in  exactly  the  same  way  to  an 
asset  disposed  of  before  the  end  of  a  specified  period.  In 
other  words,  if  an  asset,  partially  depreciated,  be  sold 
between  two  closing  dates,  two  possible  ways  exist  rela- 
tive to  the  handling: 


DEPRECIATION;  RESERVES  AND  RESERVE  FUNDS      233 


1. 


11. 


Proceed  exactly  as  above,  without  attempting  first 
to  adjust  the  depreciation  for  the  partial  period. 
Charge  the  whole  difference,  based  upon  the  last 
figures  shown  by  the  books,  directly  to  Surplus, 
because  of  the  simplicity  involved. 
First  adjust  the  depreciation  for  the  part  of  the 
period  passed,  and  then  proceed  as  indicated, 
b.  Sales  price  more  than  carrying  value.  The  difference  in- 
volved represents  a  credit  to  Surplus  account. 

Wasting  Assets.— An  asset  subject  to  depreciation  does  not 
seem  to  be  synonymous  with  an  asset  subject  to  waste,  because 
the  loss  of  value  in  each  case  does  not  take  place  in  the  same 
way.  A  wasting  asset  is  represented  by  a  mine,  a  timber  tract, 
a  patent,  or  a  leasehold,  for  example,  and,  hereunder,  the  loss 
in  value  results  because  the  asset  itself  is  used  up  either  through 
consumption,  or  through  the  passage  of  time.  A  depreciating 
asset,  on  the  other  hand,  neither  is  used  up  through  consumption, 
nor  does  it  become  reduced  in  size  by  the  passage  of  time  or  use; 
it  merely  loses  usefulness. 

Because  of  this  difference  in  the  character  of  these  two  classes 
of  assets,  each  should  be  accorded  a  different  treatment  in  the 
books  of  account.  Estimate  alone  governs  the  loss  of  value  in 
an  asset  subject  to  depreciation;  hence,  the  use  of  a  Depreciation 
Reserve  account.  On  the  other  hand,  since  a  fair  degree  of 
accuracy  may  be  secured  in  determining  the  loss  in  value  of  a 
wasting  asset,  the  use  of  a  reserve  account  seems  unnecessary, 
it  being  sufficient  merely  to  write  down  the  asset  by  direct  credits 
there  against. 

Appraisals  and  Depreciation.— Periodically,  say,  every  few 
years,  an  appraisal  of  the  capital  assets  of  a  plant  should  be 
made  by  experienced  appraisers  both  as  a  check  upon  the  accu- 
racy of  the  depreciation  charges  to  date,  and  to  establish,  in  turn, 
a  correct  basis  for  insurance  claims  should  occasion  require.  It 
should  be  remembered  that  an  accountant  is  not  an  appraiser, 
at  least  as  an  accountant ;  in  fact,  accountants  who  believe  them- 
selves appraisers  really  are  assuming  a  knowledge  of  two  tech- 
nical subjects,  with  the  result  that  most  of  them  are  not  proficient 
at  either  line  of  work. 


I 


234 


ADVANCED  ACCOUNTING 


When  an  appraisal  has  been  made,  the  attitude  of  an  account- 
ant in  relation  thereto  would  be  about  as  follows: 

1.  If  net  carrying  value  is  higher  than  appraisal  value.  In 
this  event,  the  depreciation  reserve  should  be  increased. 

2.  If  net  carrying  value  is  lower  than  appraisal  value: 

a.  If  a  fraudulent  motive  is  present  to  understate  net  worth. 
The  depreciation  reserve  should  be  increased  and,  in  the 
event  of  refusal  by  the  directors  to  do  so,  the  accountant 
should  draw  attention  to  the  appraisal  figures  in  his 
report. 

b.  If  no  fraudulent  motive  is  present  to  understate  net 
worth.  The  depreciation  reserve  need  not  be  increased, 
but  the  accountant  should  draw  attention  to  the  ap- 
praisal figures  in  his  report  because,  if  not  done,  he  may 
be  guilty  of  being  a  party  to  the  understatement  of  a«sets 
which  will  result  in  the  establishment  of  a  secret  reserve. 
(See  Part  2  of  present  chapter.) 

3.  If  market  fluctuations  have  caused  the  appraisal  to  show  an 
excess  value,  the  books  should  not  absorb  such  increase. 

4.  If  excess  past  depreciation  charges  are  responsible  for  the 
increase  of  the  appraisal  figures  over  net  carrying  value, 
such  excess  should  be  credited  to  the  Surplus  account. 

PART  2.--RESERVES  AND  RESERVE  FUNDS 
Reserve  Defined. — ^As  ordinarily  employed,  the  term  "reserve" 
has  no  definite  meaning.    Basically,  it  may  refer  to  either  one 
of  two  possibilities: 

1.  A  valuation  account  (an  asset  account  offset). 

2.  An  appropriation  of  surplus  (proprietorship  reserve). 
Sometimes,  a  third  type  is  referred  to  which  partakes  of  the 

nature  of  a  valuation  account  or  a  true  reserve,  depending  upon 
conditions.  It  is  created,  usually,  by  a  charge  to  operation  as 
in  the  first  type  above,  but  unless  an  actual  liability  exists,  it 
has  the  characteristics  of  the  second  type.  However,  the  two 
basic  types  above  shown  are  a  sufficient  differentiation  for  pres- 
ent purposes,  being  those  ordinarily  found  in  business  concerns. 
In  a  financial  institution,  concerning  which  this  book  does  not 
deal,  the  term  "reserve"  has  not  the  meaning  accorded  thereto 
above.     Hereunder,  it  refers  to  the  amount  of  cash  and  cash 


DEPRECIATION;  RESERVES  AND  RESERVE  FUNDS     235 

items  on  deposit  and  on  hand  which  legally  may  be  considered 
as  a  fund  held  against  deposits. 

Valuation  Reserves. — A  valuation  reserve  relates  to  a  charge 
against  profits  with  a  view  to  covering  an  expected  or  actual 
loss  in  asset  values.  From  the  standpoint  of  the  booked  accounts, 
such  a  reserve  may  be  said  to  be  provided  whenever  a  charge  is 
made  against  profits  without  a  corresponding  credit  being  made 
to  reduce  the  debit  balance  in  an  account  representing  an  asset. 
The  corresponding  credit  is  made  to  a  valuation  account  par- 
ticularly created  to  receive  such  credit.  Such  a  valuation  account 
never  should  be  considered  alone,  but  always  in  conjunction  with 
the  asset  account  that  it  offsets.  The  existence  of  a  valuation 
reserve  account  indicates  merely  that  there  is  an  asset  account 
present  which,  from  the  standpoint  of  the  total  net  charge  thereto, 
its  debit  balance,  is  assumed  to  be  overstated.  Common  exam- 
ples of  this  class  of  reserves  would  be: 

1.  Reserves  for  depreciation. 

a.  Buildings. 

b.  Machinery. 

c.  Etc. 

2.  Reserves  for  bad  debts. 

a.  Uncollectible  accounts  receivable. 

b.  Uncollectible  notes  receivable. 

c.  Cash  discounts  to  be  given. 

3.  Reserves  for  fluctuation  in  market  values   (where  market 
drops  below  cost). 

a.  Inventories. 

b.  Securities. 

4.  Depletion  of  natural  resources. 

a.  Mines. 

b.  Quarries. 

c.  Timber. 

d.  Oil. 
Some  accountants  would  add  another  group  of  reserves  to  the 

above  list  which  relates  to  liabilities,  as,  for  example,  reserve  for 
taxes,  reserve  for  wages  accrued,  etc.  However,  in  view  of  some 
things  which  have  been  stated  earlier,  and  which  will  be  pre- 
sented in  later  chapters,  the  opinion  is  ventured  that  such  re- 
serves are  unnecessary  inasmuch  as  when  the  liability  arises 


Questionable  as  to  being  covered  by  reserves. 


f^ 


I 


236 


ADVANCED  ACCOUNTING 


even  though  perhaps  partially  uncertain  as  to  the  exact  amount, 
the  booking  should  be  as  a  liability. 

Surplus  or  True  Reserves;  Proprietorship  Reserves.— A 
surplus  or  true  reserve  represents  amounts  which  have  been 
appropriated  from  surplus  for  some  special  purpose.  As  a  matter 
of  fact,  it  would  seem  correct  to  consider  the  Surplus  account  as 
a  reserve,  if  it  were  not  that  general  practice  does  not  thus  con- 
sider it.  In  other  words,  when  a  true  reserve  is  created,  it  is 
understood,  generally,  that  certain  portions  of  the  surplus  have 
been  set  aside  or  reserved  under  particular  informative  titles  for 
certain  specific  purposes.  Common  examples  of  this  class  of 
reserve : 

1.  Reserves  for  contingencies. 

a.  Fire  loss. 

b.  Accidents. 

c.  Obsolescence. 

d.  Guarantees. 

e.  Pending  litigation. 

2.  General  policy  reserves. 

a.  Plant  extension. 

b.  Betterments  and  improvements. 

c.  Working  capital. 

3.  Reserve  for  sinking  fund. 

As  these  reserves  stand,  with  the  possible  exception  of  (3), 
they  are  all  part  of  net  worth  since,  by  book  entry,  they  may 
be  transferred  back  into  unappropriated  surplus  and  become 
available  for  dividends.  In  fact,  at  times,  a  reserve  is  set  up 
with  the  express  purpose  in  mind  of  providing  a  means  to  equalize 
dividends  during  lean  years.  An  exception  has  been  made  in 
the  case  of  the  reserve  for  sinking  fund  in  view  of  the  fact  that 
so  many  deeds  of  trust  related  to  bond  issues  require  that  the 
sinking  fund  be  created  out  of  profits.  Hence,  the  transfer  back 
into  general  or  free  surplus  would  not  occur.  However,  since  the 
reserve  is  created  by  a  direct  charge  to  Surplus  account,  it  is  seen 
to  be  part  of  surplus.  Sinking  funds  will  be  discussed  in  the 
next  chapter. 

One  class  of  reserves  has  not  been  included  in  the  above  group- 
ing of  surplus  reserves  in  view  of  the  fact  that  their  use  appears, 
in  general,  to  be  decidedly  doubtful.    These  reserves  relate  to 


DEPRECIATION;  RESERVES  AND  RESERVE  FUNDS     237 

appreciation  in  fixed  asset  values,  as  land,  buildings,  etc.  Appre- 
ciation should  not  be  taken  up  on  a  set  of  books  unless  in  con- 
nection with  adjusting  book  figures  to  appraisal  values  where 
the  latter  are  in  excess  of  recorded  values  and  where  further 
such  excess  is  not  due  to  the  overstatement  of  certain  of  the 
valuation  reserves.  And  in  this  event,  the  unrealized  profit  should 
be  credited  to  a  special  reserve  instead  of  to  Surplus  account, 
so  that  dividends  will  not  be  paid  out  of  the  unrealized  profit. 

Reserves  and  the  Balance  Sheet.— In  interpreting  a  Balance 
Sheet,  care  must  be  observed  in  distinguishing  between  the  two 
types  of  reserves  mentioned,  inasmuch  as  frequently  no  distinc- 
tion between  them  will  be  shown.  This  would  be  true  especially, 
for  example,  in  computing  the  book  value  of  the  common  capital 
stock  of  a  company. 

Funds.— This  term  is  used  correctly  to  designate  a  grouping 
of  asset  values  brought  together  for  a  specific  purpose.  Hence, 
the  entire  stock  of  assets  that  an  individual  or  a  business  enter- 
prise has  under  its  control  and  for  its  specific  use  may  be  con- 
sidered as  a  fund.  However,  the  term  is  used  more  commonly 
to  indicate  or  set  out  a  particular  sub-grouping  of  asset  values, 
or  various  sub-groupings  thereof. 

Funds  are  of  various  kinds,  and  illustrations  thereof  may  be 
indicated  about  as  follows: 

1.  Contract  obligation  involved. 

a.  The  periodical  withdrawal  in  a  systematic  manner  of 
assets  from  the  general  fund  of  assets  (which  may  be 
represented  by  the  total  asset  values  set  out  upon  the 
left  side  of  the  Balance  Sheet)  for  the  purpose  of  meet- 
ing specific  obligations  which,  when  matured,  must  be 
paid.  A  fund  accumulated  in  this  manner  is  known, 
generally,  as  a  sinking  fund  (see  discussion  in  next  chap- 
ter). The  accumulation  of  this  fund  may  vary  with 
either  of  the  following  principles: 

i.  Periodical  deposits  of  cash  are  made,  as  yearly, 
from  the  general  fund,  into  a  special  fund.  And 
these  deposits: 

(a)  May  be  used  at  once  to  retire  a  portion  of  the 
obligation,  or 

(b)  May  be  held  in  the  special  fund  which,  peri- 


23S 


ADVANCED  ACCOUNTING 


odically,  is  increased  by  further  deposits  so 
that,  at  maturity  date,  the  obligation  can  be 
retired. 

This  method  has  no  relation  whatever  to  profits ;  hence, 
it  refers  merely  to  a  cash  accumulation  governed  by 
intervals  of  time. 

b.  The  periodical  accumulation  is  to  be  made  from  profits 
actually  earned.  Hereunder,  it  is  to  be  noticed  that 
profit  distribution  is  restricted  during  the  interval  in 
which  the  fund  is  being  increased.  The  use  of  the  fund 
thus  accumulated  may  be  varied,  also,  in  accord  with 
(a-i),  (a)  and  (b),  above. 

2.  No  contract  obligation  involved.  Hereunder,  any  person  or 
business  enterprise  may  accumulate,  convert,  and  use  its 
assets  for  its  own  ends  and  purposes,  as  is  deemed  desirable. 
Since  a  fund,  under  the  above  conditions,  may  cover  about 
any  use  capable  of  being  conceived  in  a  person's  mind,  it 
may  be  advisable  to  differentiate  roughly  between  funds 
used  ordinarily  by  corporations  involving  no  contract  obli- 
gation, and  those  used  outside  of  corporation  practice: 

a.  Non-corporate  funds. 

Endowment  fund.  This  is  related  to  some  type  of 
a  non-profit  organization,  as  a  university.  Here- 
under, a  principal  is  accumulated,  and  payments 
are  made  only  from  the  interest  received  from 
investments  of  the  principal. 
Maintenance  fund.  This  is  related  to  property 
upkeep. 

Trust  fund.     This  is  a  fund  held  by  some  one, 
called  a  trustee,  for  the  benefit  of  another,  called 
the  cestui  que  trust  (a  later  chapter  will  discuss 
certain  angles  of  this  particular  problem), 
iv.  Etc. 

b.  Corporate  funds.  ^ 
i.  Property  improvement  funds. 

ii.  Pension  funds, 
iii.  Depreciation  funds, 
iv.  Etc. 


1. 


n. 


in. 


DEPRECIATION;  RESERVES  AND  RESERVE  FUNDS      239 

Reserve  Funds.— The  capital  investment  of  a  business  is 
shown  upon  a  set  of  books  by  an  account  or  accounts  carrying 
a  credit  balance  or  balances.  And  the  sum  of  the  balances  in 
these  accounts  measures  the  net  equity  of  the  proprietors  The 
elementary  student,  in  general,  will  not  fall  into  the  error  of 
statmg,  for  example,  in  the  case  of  a  corporation,  that  either  the 
capital  stock  or  surplus,  as  set  down  upon  the  right  side  of  a 
Balance  Sheet,  is  represented  by  any  particular  assets  displayed 
upon  the  left  side  of  the  Balance  Sheet.  He  will  recognize  quickly 
that  he  cannot  point  out  particular  items  upon  the  left  side  and 
state  that  they  are  oflfsets  specifically  to  capital  stock  and  sur- 
plus. 

In  the  event  where  certain  liabilities  are  present,  representing 
debts  to  outsiders,  he  will  recognize  that  the  amount  by  which 
the  assets  exceed  in  value  the  amount  of  the  liabilities  represents 
merely  net  equity.  Likewise,  where  no  outside  liabilities  are 
present,  m  which  event  the  whole  asset  fund  is  owned  by  the 
proprietors,  he  will  recognize  that  the  interest  or  equity  of  each 
stockholder  cannot  be  stated  in  the  form  of  specific  assets  unless 
as  rarely  happens,  cash  is  the  only  asset  in  hand. 

Likewise,  since  surplus  reserves  are  only  appropriated  surplus 
It  is  not  difficult  to  comprehend  that,  in  the  ordinary  course  of 
events,  no  specific  assets  in  particular  will  represent  them  Again 
It  is  not  diflicult  to  comprehend  that  if  sufficient  assets  can  be 
changed  into  suitable  form,  these  may  be  set  aside  for  a  specific 
purpose  measured  by  certain  surplus  reserves  already  in  exist- 
ence To  restate:  Particular  assets  need  not  be  set  aside,  as  an 
offset  to  surplus  reserves,  but  they  may  be.  Further,  if  the 
illustration  be  changed  to  that  of  a  valuation  reserve,  it  is  possi- 
ble, even,  to  use  a  fund  in  connection  therewith 

And  when  specific  assets  have  been  set  aside  as  representing 
a  reserve,  a  reserve  fund  comes  into  existence.  A  fund  always 
Bhould  consist  of  assets,  and  a  reserve  fund  always  should  consist 
of  assets  which  have  been  set  aside  particularly  in  connection 
with  a  reserve.  Such  a  fund  may  consist  of  cash,  but  this  is  not 
necessarily  so,  inasmuch  as  it  may  consist  of  securities.  Again 
a  fund  may  be  restricted  as  to  use,  or  it  may  not  be  thus  re-' 
Stncted. 

It  should  be  remembered  that  no  accounting  connection  exists 


I 


240 


ADVANCED  ACCOUNTING 


between  the  creation  of  a  reserve,  even  though  it  is  possible  to 
bring  the  two  into  existence  at  the  same  time.  The  possibilities 
hereunder  are  about  as  follows: 

1.  A  reserve  may  be  created  without  a  fund. 

2.  A  fund  may  be  created  without  a  reserve. 

3.  A  reserve  and  a  fund  may  be  created  at  the  same  time. 
Finally,  a  fund  may  be  accumulated  by  periodical  appropria- 
tions, or  it  may  be  created  entirely  at  one  stroke. 

Secret  Reserves. — This  term  refers  to  the  understatement  of 
a  concern's  net  worth ;  as  a  term,  it  is  a  misnomer,  at  least  insofar 
as  the  meaning  applied  above  to  "reserve."  The  understating 
of  the  net  worth  of  a  business  enterprise  may  be  accomplished 
in  the  following  ways: 

1.  Understating  upon,  or  omitting  from,  the  books  of  account 
certain  asset  values. 

2.  Overstating  the  liabilities. 

3.  Overstating  the  valuation  reserves. 

A  common  method  of  understating  assets  is  to  either  charge 
capital  expenditures  to  revenue  or  to  make  the  depreciation 
charges  excessive. 

Certain  organizations,  particularly  banks,  are  apt  to  imder- 
state  asset  values  in  hand,  and  this  practice  results  in  the  crea- 
tion of  what  is  known  as  a  secret  reserve.  For  example,  it  i«  not 
uncommon  practice  for  a  bank  to  write  the  value  of  its  building, 
and  even  its  equipment,  entirely  off  the  books,  so  that  they  will 
not  appear  upon  the  Balance  Sheet. 

Certain  accountants  seem  to  favor  the  practice  of  creating  a 
secret  reserve,  regardless  of  the  type  of  enterprise,  on  the  ground 
that  thereunder  a  fund  of  values  is  stored  up  which  may  be 
drawn  upon  in  periods  of  depression  in  order  to  stabilize  income, 
without  drawing  upon  the  accumulated  surplus;  again,  a  large 
unexpected  loss  may  be  absorbed  without  having  the  records 
reveal  such  loss. 

The  practice  of  using  secret  reserves  can  scarcely  be  justified. 
If  statements  are  supposed  to  be  prepared  to  set  forth  the  truth 
insofar  as  human  endeavor  and  the  element  of  time  permit,  the 
secret  reserve  is  anything  but  legitimate.  Accounts  should  tell 
the  truth;  otherwise,  they  serve  no  purpose  and  are  useless. 
Theoretically,  asset  values  should  not  be  understated  any  more 


DEPRECIATION;  RESERVES  AND  RESERVE  FUNDS      241 

than  they  should  be  overstated;  if  it  is  wrong  on  the  one  hand 
It  IS  wrong  on  the  other.    Every  statement  should  set  forth  facts' 
regardless  of  whether  it  covers  a  bank  or  any  other  type  of 
enterprise;  too  many  misstatements  of  fact  occur  in  the  attempt 
of  many  accountants  to  follow  out  a  policy  of  conservatism.  The 
oft-repeated   expression  that   "an   accountant  should   never   be 
considered  m  error  so  long  as  he  is  conservative"  ought  never  to 
have  been  advanced.    There  is  a  limit  beyond  which  conserva- 
tism does  more  harm  than  good.    Further,  in  these  days  of  varied 
taxes,  especially  taxes  upon  incomes,  the  facts  should  be  stated 
as  they  are,  consistent  with  the  training  and  experience  ordinarily 
assumed  as  belonging  to  the  accountant  who  is  deemed  to  be  a 
qualified  man  in  his  particular  line  of  work. 

PART  3.— SURPLUS  AND  DIVIDENDS 
Corporate  Net  Worth.-The  net  capital  of  a  corporation, 
represented  by  total  assets  less  total  outside  liabilities,  measures 
the  amount  of  the  organization's  proprietary  interest  or  net 
worth.  The  Capital  Stock  account  is  the  principal  proprietary 
account  in  a  corporation,  but  not  necessarily  the  only  one  At 
the  commencement  of  operations,  it  may  be  possible  to  assume 
a  proprietary  interest  equal  in  amount  to  the  Capital  Stock  but 
as  soon  as  operations  commence,  the  proprietary  interest 'will 
be  either  greater  or  less  than  the  capital  stock. 

If  a  corporation  proves  to  be  successful,  profits  will  be  made 
and  If  these  profits  are  not  all  withdrawn,  the  result  will  be  an 
increase  in  proprietary  interest.  This  increase,  however,  cannot 
be  credited  direct  to  the  Capital  Stock  account  in  view  of  the 
fact  that  the  latter  is  fixed  in  amount;  hence,  the  necessity  of 
providing  another  proprietary  account  therefor.  This  second 
account  is  known,  generally,  as  the  Surplus  account.  And  in 
general  it  may  be  said  that  this  account,  when  properly  con- 
structed, should  be  built  up  by  credits  representing  only  undi- 
vided profits  which,  at  the  moment  of  booking,  will  be  available 
lor  purposes  of  distribution  in  the  form  of  dividends. 

On  the  other  hand,  if  a  corporation  does  not  prove  to  be  suc- 
cessful, with  the  result  that  the  surplus  has  been  exhausted  and 
that  subsequently  the  losses  are  greater  than  the  profits  the 
latter  should  be  debited  to  a  Deficit  account.    This  account  will 


242 


ADVANCED  ACCOUNTING 


carry  a  debit  balance.  Further,  it  is  not  an  asset,  but  merely 
a  book  account  explaining  the  difference  between  the  assets  and 
the  sum  of  the  liabilities  plus  investment.  In  determining  cor- 
porate net  worth,  the  Deficit  account  must  be  considered  in 
connection  or  in  combination  with  the  other  proprietorship 
accounts. 

Practically  every  corporation  will  have  on  its  books  either  a 
Surplus  account  or  a  Deficit  account,  this  being  due  to  the  fact 
that,  in  general,  the  Capital  Stock  account  never  will  measure 
the  amount  of  the  net  worth. 

However,  surplus  may  be  of  a  type  other  than  the  one  advo- 
cated above.  If  the  possible  kinds  of  surplus  be  classified,  the 
following  will  result: 

1.  Surplus  accumulated  out  of  past  profits.    In  turn,  this  sur- 
plus may  be  divided  further  into: 

a.  Appropriated  or  restricted  surplus. 

b.  Free  surplus.    This  represents  past  profits  retained  which 
are  available  for  dividends. 

2.  Surplus  created  by  contribution.    Hereunder,  the  creation 
will  be  due  to  one  of  the  following  causes: 

a.  Sale  of  stock  at  a  premium. 

b.  Stock  donation. 

3.  Surplus  created  by  revaluation.     Hereunder,  the  creation 
will  be  due  to  one  of  the  following  causes: 

a.  Increasing  book  valuations  of  capital  assets. 

b.  Reducing  par  value  of  the  capital  stock. 

The  cause  of  uniformity  in  accounting  terminology  would  be 
aided  considerably  if  persons  had  the  same  idea  in  mind  when 
speaking  of  surplus.  And  to  this  end,  the  suggestion  is  made 
that  since  the  average  individual  considers  surplus  as  represent- 
ing something  out  of  which  dividends  may  be  paid,  its  use,  as  a 
term,  ought  to  be  that  indicated  by  (1-b^  above. 

Classes  of  Dividends. — Dividends,  as  discussed  in  the  present 
chapter,  relate  to  corporate  profits  which  are  to  be  distributed  to 
the  stockholders,  not  to  certain  other  particular  payments  to  be 
made  to  stockholders  which  often  are  given  the  title  of  *'divi- 
dends,"  as,— liquidating  dividend.  Basically,  the  following  dis- 
cussion of  dividends  may  be  outlined  briefly  about  as  follows: 


DEPRECIATION;  RESERVES  AND  RESERVE  FUNDS      243 

1.  Source. 

a.  From  capital. 

b.  From  profits. 

2.  Manner  of  payment. 

a.  Cash. 

b.  Property. 

c.  Bonds. 

d.  Stock. 

e.  Scrip. 

Capital  Versus  Profits— Relation  to  Dividends.— In  cor- 
porate work,  there  exist  two  distinct  funds  of  values: 

1.  Contributed  capital.  This  fund  of  values  is  presumed  to  be 
used  only  for  financing  purposes.  Further,  this  fund  is  not 
to  be  returned  to  the  stockholders  except  under  the  follow- 
ing circumstances,  each  of  which  is  governed  by  statute: 

a.  When  the  capital  stock  is  formally  reduced. 

b.  When  the  company  is  dissolved. 

In  other  words,  except  when  reduced  by  the  sufferance 
of  losses,  the  stockholders,  ordinarily,  have  no  right  tp  with- 
draw any  of  this  fund;  the  corporation  has  no  legal  right 
to  distribute  its  capital  to  the  stockholders  except  under 
either  of  the  conditions  mentioned  above.  This  general 
rule,  however,  is  subject  to  one  exception,  in  the  case  of 
corporations  operating  by  virtue  of  depleting  some  natural 
resource. 

2.  Profits.    A  second  fund  of  values  grows  out  of  the  operating 

activity   of   a   corporation;    it   results    from   profits    being 

earned.     This  fund  of  values  may  be  distributed  to  the 

stockholders  under  certain  conditions: 

a.  The  board  of  directors,  by  formal  action,  must  declare  a 

dividend.     By  such  action,  the  board  of  directors,  who 

are  the  representatives  of  the  stockholders,  set  aside  a 

portion  of  the  profits  that  have  been  earned,  and  when 

this  setting  aside  has  been  accomplished  in  due  form 

under  the  law,  there  can  be  no  rescinding  of  the  action ; 

hence,   after   a   dividend   has   been   declared,   payment 

thereof  may  be  enforced  by  the  stockholders,  provided 

such  declaration  be  made  in  due  and  legal  form. 


244 


ADVANCED  ACCOUNTING 


b.  There  must  be  sufficient  profits  on  hand  to  meet  the 
possible  contingencies  that  may  arise  before  a  dividend 
declaration  is  in  order.  This  condition,  however,  is  not 
governed  by  the  law  as  is  the  first  one  above.  A  divi- 
dend might  be  declared  equal  to  the  full  amount  oi  the 
profits  earned,  but  conservative  management,  for  the 
reason  just  mentioned,  will  not  favor  any  attempt  to 
withdraw  the  entire  amount  of  the  profits  from  a  busi- 
ness. Because  of  possible  contingencies,  a  prudent  man- 
agement will  attempt  to  build  up  a  substantial  surplus 
margin  in  anticipation  of  the  evil  day;  and  in  certain 
organizations  this  policy  of  conservatism  is  followed  so 
consistently  from  year  to  year  that  eventually  the  Bal- 
ance Sheet  will  disclose  a  legitimate  surplus  so  large*  that 
it  is  many  times  larger  than  the  total  capital  stock. 

Because  of  the  shortsightedness  and  lack  of  understanding  on 
the  part  of  stockholders, — ^their  continual  clamoring  for  large 
dividends,  plus  their  attitude  that  a  large  surplus  represents 
something  that  should  be  paid  over  to  them  and  when  not  so  paid 
indicates  mismanagement, — it  is  customary  to  reserve  certain 
portions  of  the  surplus  in  a  manner  that  will  make  them  unavail- 
able for  dividend  purposes.  The  result  of  this  practice,  plus  the 
legal  theory  underlying  the  two  funds  referred  to  above,  would 
seem  sufficient  reason  for  revamping  the  set  out  of  these  two 
funds  about  as  follows: 

1.  Capital  fund.    This  may  be  represented  as  under: 

a.  The  par  value  of  the  capital  stock  issued  and  outstanding. 

b.  Profits  appropriated  by  formal  action  for  capital  uses. 

2.  Earned  profits  or  surplus  available  for  dividends: 

a.  Free  surplus. 

b.  Surplus  appropriated  for  distribution  by  virtue  of  a 
specific  dividend  declaration  in  due  and  legal  form. 

Surplus  Profits. — The  liability  of  corporate  stockholders 
being  limited,  in  general,  to  the  amount  that  they  have  invested 
in  a  corporation,  as  represented  by  the  shares  of  stock  held,  seems 
to  be  the  basis  for  the  numerous  conflicting  opinions  of  judges 
and  accountants  as  to  what  is  a  corporate  profit  available  for 
dividend  pm*poses.     Since  it  is  a  fundamental  legal  rule  that 


DEPRECIATION;  RESERVES  AND  RESERVE  FUNDS     245 

corporations,  with  the  exception  of  companies  operating  in  con- 
nection with  a  natural  resource,  must  not  pay  dividends  out  of 
capital,  it  follows  that  dividends  can  be  distributed  only  from 
surplus  profits.  No  difficulty  would  be  encountered  in  connection 
with  the  subject  of  dividends  if  it  were  possible  to  secure  as 
simple  an  interpretation  of  this  principle  or  rule  as  is  its  state- 
ment; however,  regardless  of  statutes  and  court  decisions,  a  satis- 
factory definition  of  the  term  "surplus  profits"  does  not  seem  to 
have  been  offered. 

Accountants  commonly  define  corporate  surplus  as  the  excess 
of  the  assets,  valued  conservatively,  over  the  sum  of  the  liabili- 
ties plus  capital  stock.  Legal  decisions  supporting  the  above 
definition  consider  surplus  profits  as  being  the  excess  of  the 
assets  over  the  sum  of  the  liabilities  and  capital  stock,  such 
excess  being  actual  and  not  the  result  of  an  appraisal.  However 
in  delving  further  into  the  subject,  a  conflicting  maze  of  decisions' 
is  encountered,  as  well  as  decisions  in  conflict  with  generally 
recognized  practice.    The  following  are  illustrative: 

1.  A  concern  makes  a  net  business  profit  of  $40,000.00,  but 
suffers  a  capital  loss  of  $50,000,00.  Legally,  a  dividend  of 
$40,000.00  could  be  paid,  but  prudence  may  not  favor  such 
a  procedure.  Legally,  a  deficit  might  be  carried  along  with 
no  attempt  being  made  to  write  it  off  against  current  profits. 

2.  Profit  secured  from  the  sale  of  fixed  assets  may  be  distrib- 
uted as  dividends. 

3.  A  surplus  profit  may  be  secured  by  a  company  converting 
some  of  its  bonds  into  stock  at  a  figure  above  par. 

4.  A  surplus  profit  may  be  secured  by  selling  bonds  at  a  pre- 
mium; on  the  other  hand,  premiums  on  stock  may  be 
distributed,  but  are  not  legally  profit  and,  therefore,  such 
distribution  should  not  be  considered  as  a  dividend. 

Illegal  Dividends.— The  only  point  to  be  considered  here 
relates  to  the  illegal  declaration  of  a  dividend  by  the  directors 
Most  states  have  statutes  which  hold  directors  personally  liable 
for  losses  suffered  by  company  creditors  due  to  the  fact  that  they 
have  reduced  the  capital  fund  through  the  payment  of  dividends 
Naturally,  this  contingency  will  not  arise  so  long  as  creditors  are 
paid  as  bills  mature,  but  the  possibility  is  ever  present  that  by 


246 


ADVANCED  ACCOUNTING 


!.- 


virtue  of  business  reverses  these  outstanding  obligations  cannot 
be  met.  Hence,  directors  ever  should  be  careful  in  declaring  and 
paying  a  dividend. 

The  type  of  statute  referred  to  above  is  well  exemplified  by  the 
statute  existent  in  New  York  which  reads  as  follows  (S.  C.  L.; 
Art.  3,  No.  28) : 

The  directors  of  a  stock  corporation  shall  not  make  dividends,  except 
from  the  surplus  profits  arising  from  the  business  of  such  corporation, 
nor  divide,  withdraw  or  in  any  way  pay  to  the  stockholders  or  any  of 
them,  any  part  of  the  capital  of  such  corporation,  or  reduce  its  capital 
stock,  except  as  authorized  by  law.  In  case  of  any  violation  of  tlie  pro- 
visions of  this  section,  the  directors  under  whose  administration  the  same 
may  have  happened,  except  those  who  may  have  caused  their  dissent 
therefrom  to  be  entered  at  large  upon  the  minutes  of  such  directors  at  the 
time,  or  were  not  present  when  the  same  hapjM'ned,  shall  jointly  and 
severally  be  hable  to  such  corporation  and  to  the  creditors  thereof  to 
the  full  amount  of  any  loss  sustained  by  such  corporation  or  its  creditors 
respectively  by  reason  of  such  withdrawal,  divi>?ion  or  reduction.  But 
this  section  shall  not  prevent  a  division  and  distribution  of  the  assets  of 
any  such  corporation  remaining  after  the  payment  of  all  its  debt-R  and 
liabilities  upon  the  dissolution  of  such  corporation  or  the  expiration  of 
its  charter;  nor  shall  it  prevent  a  corporation  from  accepting  shares  of 
its  capital  stock  in  complete  or  partial  settlement  of  a  debt  owing  to  the 
corporation,  which  by  the  board  of  directors  shall  be  deemed  to  be  bad 
or  doubtful. 

Similarly,  in  the  case  of  a  corporation  authorized  to  issue 
shares  without  nominal  or  par  value,  another  section  of  the  law 
states  as  follows  (S.  C.  L.;  Art.  2,  No.  20): 

No  such  corporation  shall  declare  any  dividend  which  shall  reduce 
the  amount  of  its  capital  below  the  amount  stated  in  the  certificate  as 
the  amount  of  capital  with  which  the  corporation  will  carry  on  business. 
In  any  case  such  dividend  shall  be  declared,  the  directors  in  whose 
administration  the  same  shall  have  been  declared,  except  those  who 
may  have  caused  their  dissent  therefrom  to  be  entered  upon  the  minutes 
of  such  directors  at  the  time  or  who  were  not  present  when  such  action 
was  taken,  shall  be  liable  jointly  and  severally  to  such  corporation  and 
to  the  creditors  thereof  to  the  full  amount  of  any  loss  sustain(;d  by 
such  corporation  or  by  its  creditors  respectively  by  reason  of  such 
dividend. 

An  illegal  dividend  may  be  revoked  any  time  before  payment 
is  made;  further,  if  such  dividend  has  been  paid^  revocation  is  in 


DEPRECIATION;  RESERVES  AND  RESERVE  FUNDS     247 


order  only  as  concerns  the  stockholders  who  know  that  the 
source  is  illegal. 

Mining  Company  Dividends. — In  the  case  of  companies, 
where  the  value  of  the  capital  asset, — mine,  quarry,  timber  tract, 
etc., — is  being  decreased  on  account  of  current  operations,  good 
accounting  should  demand  the  application  of  a  portion  of  each 
period's  profits  against  the  book  value  of  the  wasting  asset  so 
that  such  book  value  will  be  extinguished  completely  at  the  end 
of  its  life.  However,  it  would  seem  that  the  application  of  this 
principle  is  dependent  upon  the  fact  of  whether  or  not  it  is 
possible  to  determine  with  any  fair  degree  of  accuracy  the  num- 
ber of  units  of  product  available  for  use.  Take  the  case  of  a 
mining  company  as  an  example: 

1.  If  possible  to  determine  the  available  units  of  product  with 
a  fair  degree  of  accuracy,  the  reduction,  or  so-called  depre- 
ciation, may  be  based  upon  the  number  of  units  taken  out, 
to  the  end  that  the  wasting  asset  will  be  amortized  over  the 
period  of  its  usefulness  so  that  finally,  at  the  end  of  such 
period,  it  will  have  been  replaced  from  profits  in  another 
form.  In  this  event,  stockholders'  dividends  will  not  con- 
sist partly  of  profits  and  partly  of  a  return  of  capital,  in- 
asmuch as  the  capital  return  will  be  made  all  at  one  time. 

2.  If  impossible  to  determine  the  factors  mentioned  above, 
and  explanation  exists  to  the  end  that  the  stockholders  and 
creditors  of  such  a  company  are  aware  of  actual  conditions, 
it  would  seem  proper  and  in  order  to  have  the  dividends 
consist  of  both  profits  and  a  capital  return.  However,  al- 
though this  practice  is  followed  to  a  considerable  extent, 
such  companies  being  excused  from  following  out  any  policy 
of  amortization,  it  appears  that  such  procedure  should  not 
be  in  order  unless  the  stockholders  and  creditors  are  in- 
formed fully  of  the  facts  of  the  case  to  the  end  that  they 
will  not  labor  under  a  delusion  that  the  entire  dividend  re- 
ceived from  time  to  time  consists  of  nothing  but  profits. 

Realizing  Upon  Assets  to  Pay  a  Dividend. — The  principle 
that  arises  in  connection  with  the  matter  of  determining  profits 
correctly  may  be  considered  as  dividing  itself  into  the  following 
parts: 


248 


ADVANCED  ACCOUNTING 


1.  Since  it  is  impossible  to  allocate  a  particular  asset  either 
to  the  capital  fund  or  to  the  profit  fund,  care  must  ])e  ob- 
served, insofar  as  operations  and  activities  are  concerned, 
to  make  certain  that  current  income  will  absorb  all  cliarges 
possible  to  the  end  that  the  capital  plant  may  be  kept 
intact. 

2.  In  turn,  this  leads  one,  first,  into  the  question  of  valuation 
of  assets: 

a.  As  to  current  assets. 

i.  Profits  should  not  be  anticipated. 

b.  As  to  capital  assets. 

i.  Depreciation  must  be  calculated  most  carefully. 

ii.  Surplus  additions  secured  through  marking  uj)  the 
fixed  asset  values,  if  such  procedure  be  tolerated  at 
all,  should  be  so  earmarked  that  a  dividend  will 
not  be  declared  from  what  is  a  mere  book  increase 
not  offset  by  an  actual  increase  in  the  asset  fund 
contra. 

3.  Next,  one  should  realize  that,  before  a  dividend  be  declared, 
the  following  points  must  be  taken  seriously  into  considera- 
tion: 

a.  The  need  for  additional  capital  may  be  such  that  avail- 
able profits  should  be  used  for  this  purpose. 

b.  Because  of  depreciation,  the  assets  may  shrink  to  such 
a  point  that  the  apparent  profits  do  not  actually  exist. 

c.  Current  assets  are  exceedingly  slow  of  realization. 
Because  of  the  above,  the  process  of  transforming  or  reducing 

profits  to  a  specific  cash  fund  available  for  dividends  is  somewhat 
difficult  and  complicated.  In  practice,  therefore,  where  a  suffi- 
cient realization  of  the  importance  of  the  above  points  is  in 
order,  dividends  are  not  declared  hastily.  Further,  after  their 
declaration,  the  payment  thereof  will  be  deferred  sufficiently  to 
the  end  that  cash  may  be  secured  and  withdrawn  in  order  to 
make  payment. 

The  Supreme  Court  decisions  are  vague  as  to  what  constitutes 
net  profit.  Although  a  general  reading  thereof  would  lead  one 
to  believe  that  profits  must  be  realized  in  cash  before  a  dividend 
may  be  paid,  it  seems  reasonable  to  assume  that  such  a  literal 
interpretation  is  not  in  order  in  view  of  the  fact  that  by  so  do- 


DEPRECIATION ;  RESERVES  AND  RESERVE  FUNDS      249 

ing  there  would  be  no  agreement  with  elementary  accounting 
principles : 

1.  If  accounting  be  done  entirely  upon  a  cash  basis,  the  literal 
mterpretation  would  seem  to  apply.  However,  except  in 
the  smallest  of  concerns,  a  cash  basis  of  accounting  is  not 
followed  in  that  thereunder  the  exact  truth  relative  either  to 
financial  position  or  to  profits  cannot  be  expressed  in  the 
accounting  statements. 

2.  If  accounting  be  done  upon  an  accrual  basis,  this  literal 
mterpretation  could  not  be  followed  with  reason,— in  ac- 
cord with  at  least  one  elementary  accounting  principle,  to 
the  effect  that  a  profit  is  assumed  to  be  realized  at  the 
moment  a  sale  is  made,  which  means  at  the  moment  a 
cause  of  action  arises,  regardless  of  whether  actual  cash  has 
been  received  or  some  other  asset,  as  an  open  account  re- 
ceivable, a  note  receivable,  or  other  goods. 

If  the  directors  in  good  faith  declare  and  pay  a  dividend  before 
profits  actually  are  realized  in  cash,  it  appears  that  no  liability 
would  be  incurred  by  them  should  the  values  out  of  which  the 
dividends  are  expected  to  be  paid  never  be  realized.  But  even  so, 
conservatism  dictates  that  dividends  should  be  paid  only  from 
realized  profits. 

Declaring  and  Paying  Dividends.— The  directors  of  a  cor- 
poration  are  not  required  to  distribute  profits  to  the  stockholders 
unless,  in  their  discretion,  it  seems  proper  to  do  so.  This  means 
that  before  so  doing  they  have  the  specific  duty  of  protecting 
the  capital  fund  of  the  enterprise  and  in  this  connection  they 
should  make  use  of  the  undistributed  profits  in  any  way  that 
seems  best.  And  when  it  has  been  decided  to  declare  a  dividend, 
the  provisions  of  the  charter  and  of  the  by-laws  must  be  fol- 
lowed; outside  of  this  circumscription,  in  the  absence  of  fraud, 
the  directors  control  entirely  the  declaration  of  a  dividend. 

The  directors  may  exercise  their  judgment  and  discretion  in 
paying  dividends  and  when,  in  good  faith,  dividends  are  with- 
held, nothing  can  be  done  to  force  payment  except  by  a  ma- 
jority of  the  stockholders  electing  a  new  board  of  directors  who 
will  be  subservient  to  their  wishes.  But  if  any  improper  with- 
holding can  be  shown,  the  obligation  rests  upon  the  directors  to 
explain  why  a  distribution  is  not  in  order;  under  such  circum- 


250 


ADVANCED  ACCOUNTING 


stances,  legal  action  may  order  the  declaration  and  payment  of 
a  dividend. 

Only  after  proper  provision  has  been  made  for  protecting  the 
capital  fund,  should  the  question  of  profit  distribution  be  con- 
sidered. Premature  declaration  and  payment  to  satisfy  clamor- 
ing stockholders  temporarily  may  keep  up  current  market  values 
of  stock,  and  result  in  deceiving  these  stockholders  into  believing 
the  management  successful,  but  the  policy  is  a  short-sighted 
one  which: 

1.  Starves  business  development. 

2.  May  lead  into  insolvency. 

These  stockholders  lose  sight  of  the  fact  that  a  present  cur- 
tailment of  dividend  payments  may  mean: 

1.  Securing  the  necessary  working  capital  with  which  to  carry 
on  operations  and  which  could  not  be  secured  in  any  other 
way  except  possibly  by  incurring  heavy  interest  charges. 

2.  Development  and  expansion. 

3.  Payment  of  larger  and  steadier  dividends  in  the  future. 
The  Minute  Book  should  contain  all  the  information  relative 

to  dividend  rate,  date,  and  manner  of  payment.  As  soon  as  a 
legal  dividend  has  been  declared  by  the  directors,  and  notice  has 
been  given  thereof  the  stockholders  have  a  right,  each  to  his 
proper  pro  rata  share,  and  such  right  cannot  be  curtailed  in  any 
way  by  the  directors.  Dividend  declaration  may  be  revoked 
at  any  time  by  the  directors  up  to  the  moment  public  notice 
thereof  is  issued;  thereafter,  revocation  is  not  in  order  except 
when  the  dividends  are  illegal.  The  stockholders  to  whom  divi- 
dends are  payable  will  be  those  whose  names  appear  upon  the 
corporate  records  as  of  a  certain  date, — ^the  stockholders  of 
record;  hence,  dividends  are  not  payable  upon  treasury  stock. 
Even  though  certain  shares  of  stock  may  be  owned  by  some  one 
other  than  the  person  whose  name  appears  upon  the  corporate 
books,  the  dividend  is  payable  to  the  stockholders  of  record;  any 
error  arising  hereunder  based  upon  circumstances  not  of  record, 
is  a  problem  to  be  adjusted  between  the  stockholders  in  interest. 
The  company  is  not  interested  beyond  its  records  as  to  whether 
the  owner  of  record  is  the  actual  owner  of  the  stock  or  not  the 
actual  owner. 
The  procedure  in  connection  with  the  declaration  and  payment 


DEPRECIATION;  RESERVES  AND  RESERVE  FUNDS      251 

of  a  dividend  depends  upon  the  size  of  the  corporation  in  ques- 
tion and  whether  or  not  the  stock  is  held  by  few  or  many  per- 
sons: 

1.  Small  close  corporation. 

a.  Dividend  declaration  is  made  but  no  formal  notice  pub- 
lished. 

b.  The  books  are  not  closed  in  order  to  prepare  the  list  of 
those  to  whom  dividends  are  payable. 

2.  Small  corporation — not  a  close  corporation. 

a.  The  procedure  hereunder  follows  that  of  the  large  cor- 
porations except  that  the  volume  of  detail  in  connection 
therewith  is  small  (see  3  below). 

3.  Large  corporation  with   stock  widely   dealt  in  upon  the 
market. 

a.  Notice  published  to  the  effect  that  a  dividend  has  been 
declared  as  of  a  certain  date  payable  to  the  stockholders 
of  record  as  of  a  date  sufficiently  far  in  the  future  to 
permit  of  the  actual  owners  becoming  stockholders  of 
record  before  the  date  mentioned,  upon  which  the  Trans- 
fer Books  will  be  closed. 

b.  The  Transfer  Books  are  closed  upon  the  date  set,  and 
remain  closed  for  a  certain  number  of  days  thereafter 
in  order  that  the  dividend  list  may  be  prepared  cor- 
rectly. When  these  books  are  open  again,  transfers  are 
made  thereon  in  the  usual  way  as  before. 

c.  Great  care  is  exercised  in  preparing  the  dividend  list 
which,  when  completed,  must  be  certified  to  as  correct 
by  the  officer  who  has  charge  of  stock  transfers. 

d.  After  the  dividend  list  has  been  certified  to  as  correct, 
it  is  given  to  the  treasurer,  or  to  whoever  handles  the 
cash  payments,  checks  are  drawn,  and  payment  made. 

e.  Dividends,  usually,  are  paid  by  checks  drawn  to  the 
order  of  the  stockholders  of  record  as  of  the  date  speci- 
fied. These  checks  are  prepared  upon  the  basis  of  the 
dividend  list  referred  to  above. 

As  a  rule,  the  voucher  check  is  used  in  connection  with  the 
payment  of  dividends  and,  in  a  large  company,  such  checks  are 
designed  specifically  for  this  purpose  in  which,  at  least,  the  num- 
ber of  the  dividend  is  stamped  or  printed.    If  a  special  check  is 


252 


ADVANCED  ACCOUNTING 


printed  for  each  dividend,  the  number  and  rate  of  the  dividend 
would  be  printed  thereon;  if  not,  blank  spaces  would  be  left  in 
which  this  information  may  be  stamped.  The  advantages  of 
using  such  a  form  of  check  hereunder  are: 

1.  Proof  of  payment  on  hand  in  case  of  dispute. 

2.  Sufficient  information  on  each  check  to  make  an  accom- 

panying form  letter  unnecessary. 

3.  Indorsement  by  stockholder  constitutes  sufficient  acknow- 
ledgment. 

Corporate  net  profits  or  income  for  a  current  period,  prior  to 
transfer,  is  found  as  a  credit  balance  in  a  Profit  and  Loss 
account  carried  upon  the  Ledger  in  the  usual  way.  From  that 
point  on,  no  uniformity  exists  either  in  the  disposal  of  this 
balance  or  in  booking  a  dividend  which  may  be  declared  out 
of  such  profit.  In  outline  form,  the  variations  may  be  indicated 
about  as  follows: 

1.  Since  corporate  net  profit  or  net  loss  cannot  be  absorbed  in 
the  Capital  Stock  account  or  accounts,  its  disposal  from 
the  Profit  and  Loss  account  may  be  as  under: 

a.  To  Surplus  account. 

b.  To  Undivided  Profits  account.  From  time  to  time  round 
amounts  are  transferred  to  Surplus  account.  The 
balance  in  the  Undivided  Profits  account  is  used  for 
dividend  payments.    Banks  follow  this  practice. 

2.  The  entries  in  connection  with  declaring  and  paying  divi- 
dends are  simple,  and  are  about  as  follows: 

a.  Declaration  of  dividends  (liability  incurred) : 


1.  Surplus  Account, 

To — Dividend  Payable  Account, 
ii.  Profit  and  Loss  Account, 

To — Dividend  Payable  Account, 
Surplus  Account, 
iii.  Undivided  Profits  Account, 

To — Dividend  Payable  Account, 


«  i 


The  second  possibility  is  unsatisfactory  in  view  of  the 
fact  that  if  current  profit  is  not  sufficient  for  dividend  pur- 
poses, the  dividend  still  may  be  paid  if  sufficient  accumu^ 
lated  profits  are  on  hand ;  naturally,  these  latter  are  shown 
in  the  Surplus  account.    Hence,  charging  the  dividend  to 


DEPRECIATION;  RESERVES  AND  RESERVE  FUNDS      253 

the   Profit  and   Loss   account   makes   matters   somewhat 
confused. 

b.  Payment  of  dividends: 


i.  Dividend  Payable  Account, 
To — Cash, 


S  i 


%  i 


Final  dividend  declaration  always  should  precede  divi- 
dend payment;  never  should  the  reverse  practice  be  fol- 
lowed. 

Care  should  be  observed  to  book  the  liability  incurred  by 
virtue  of  a  dividend  declaration  immediately  upon  such  declara- 
tion and  notice  thereof.  An  unpaid  dividend  is  a  current  liabil- 
ity to  be  set  out  upon  the  Balance  Sheet  as  such.  Ofttimes,  a 
considerable  portion  of  a  dividend  payment  will  remain  un- 
claimed, the  issued  checks  being  returned  through  the  post  office. 
In  this  connection,  it  may  be  advisable  to  send  them  out  again 
by  registered  mail,  and  if  still  unclaimed,  then  to  transfer  them 
to  a  special  fund  account.  Unclaimed  dividends  cannot  be  re- 
turned to  surplus  except  by  action  of  the  directors.  If  the  above 
expedient  be  followed  in  connection  with  attempting  to  locate 
the  persons  to  whom  the  dividends  are  payable,  it  would  seem 
that  upon  the  return  of  unclaimed  dividends  to  surplus,  a  pro- 
portionate amount  of  the  special  cash  fund  could  be  returned 
to  general  cash  there  to  be  available  for  general  purposes. 

Stock  and  Scrip  Dividends.— Surplus  profits  commonly  are 
capitalized  by  the  declaration  of  a  stock  dividend.  In  amount, 
such  dividend  cannot  exceed  the  amount  of  the  surplus;  it  is 
payable  in  capital  stock,  the  par  value  thereof  equaling  the 
amount  of  the  dividend.  In  other  words,  a  stock  dividend  merely 
converts  a  pro  rata  equity  of  each  stockholder  in  unappropriated 
profits  to  the  tangible  form  of  stock  rights.  After  the  conversion, 
the  total  interest  of  each  stockholder  will  be  the  same  amount 
as  was  previously  shown;  each  stockholder's  interest  thereafter 
has  increased  so  far  as  stock  interest  is  considered,  but  has 
decreased  so  far  as  the  equitable  interest  in  surplus  profits  is  con- 
cerned, the  increase  and  decrease  being  of  a  similar  amount. 
The  advantages  of  issuing  a  stock  dividend  may  be  sum- 
marized as: 

1.  The  stockholder  may  realize  a  certain  amount  of  profit  by 


U 


254 


ADVANCED  ACCOUNTING 


\i 


selling  some  oi  his  new  stock  which  would  not  be  possible 
by  selling  the  same  proportionate  amount  of  old  stock. 
2.  Thereunder,  a  portion  of  corporate  profit  is  capitalized  for 
the  permanent  use  of  the  concern.  And  in  this  connection, 
the  big  difference  between  such  a  dividend  and  a  regular 
dividend  is  most  noticeable;  a  regular  dividend  distributes 
assets  that  have  been  absorbed  by  the  corporation  as 
profits,  whereas,  a  stock  dividend  retains  these  profit  assets 
capitalizing  them  for  corporate  use.  Hence,  no  profit  dis- 
tribution is  made. 

So  long  as  a  surplus  profit  exists,  a  dividend  may  be  de- 
clared, even  though  there  is  not  sufficient  cash  on  hand  with 
which  to  make  payment.  Payment  may  be  made  in  assets  other 
than  cash;  cash  may  be  borrowed  for  dividend  purposes,  if  con- 
ditions seem  to  warrant  the  use  of  the  expedient;  a  stock 
dividend  may  be  declared ;  a  scrip  dividend  may  be  declared. 

Scrip  represents  nothing  but  a  promise  to  pay.  It  is  & 
temporary  expedient  in  the  way  of  a  corporate  promise  to  pay, 
indicating  either  of  the  following: 

1.  Some  document  into  which  it  is  to  be  converted  at  a  lat^r 
date.  If  it  is  impracticable  to  have  a  stock  certificate  or  a 
bond  ready  for  delivery  as  of  a  specified  date,  scrip  will 
be  issued. 

2.  Some  value  into  which  it  is  to  be  converted  at  a  later  date. 
Hereunder,  scrip  may  be  issued  temporarily  to  settle  a 
dividend,  same  to  be  redeemable  in  cash  at  a  certain  future 
date.  This  scrip  practically  may  be  equivalent  to  cash 
where  passed  readily  from  hand  to  hand.  Again,  the  scrip 
may  be  payable  in  stock;  hence,  a  stock  dividend  may  be 
covered  temporarily  by  the  issue  of  scrip.  Further,  if  in- 
terest is  due  and  cash  not  available  for  payment,  scrip  may 
be  issued.  Lastly,  scrip  may  be  issued  for  fractional  parte 
of  a  share  of  stock  or  of  a  bond  when  securities  are  being 
distributed. 

In  the  accounts,  "scrip"  will  show  up  as  an  account  with  a 
credit  balance: 


■H^ 


1.  If  it  represents  a  deferred  dividend  paynaent: 

An  Income  Account,  §  ^ 

To — Dividend  Scrip  Account, 


I  ^ 


DEPRECIATION,  RESERVES  AND  RESERVE  FUNDS      255 

2.  If  it  represents  interest  due  to  be  paid  for  which  cash  funds  are  not 
available: 

An  Expense  Account,  $  i 

To — Interest  Scrip  Account,  $  ^ 

3.  If  it  represents  the  temporary  coverage  of  a  stock  dividend: 
Surplus  Account,  $  ^ 

To — Stock  Dividend  Scrip  Account,  $  ^ 

4.  If  it  represents  some  document  into  which  later  conversion  will  be 
made: 

An  Asset  Account  (representative  of  elements 
received  for  securities),  $  ^ 

To — Stock  Scrip  or  Bond  Scrip  Account,  $  ^ 

Cumulative  Dividends. — These  arise  in  connection  with 
preferred  stock,  at  the  time  when  a  preferred  stock  dividend  is 
passed.  A  number  of  methods  exist  relative  to  stating  cumula- 
tive dividends  which  have  been  passed.  However,  since  no 
liability  exists  relative  to  a  dividend  until  the  latter  Jias  been 
declared,  it  would  seem  that  no  entry  relative  to  a  passed 
cumulative  dividend  is  necessary,  it  being  sufficient  merely  to  set 
it  out  upon  the  Balance  Sheet  as  a  footnote. 

Profit-Sharing. — This  term  arises  when  a  portion  of  the 
profits  of  an  enterprise  are  distributed  to  the  employees.  The 
term  is  not  synonymous  with  that  of  "dividends,"  since  the 
former  merely  represents  a  bonus  and  nothing  else.  The  entries 
to  cover  would  be  about  as  follows: 


1.  Profit  and  Loss  (or  Surplus), 

To — Employees'  Bonus, 

2.  Employees'  Bonus, 

To— Cash, 


S  i 


►  t 


CHAPTER  VIII 

CORPORATE  OBLIGATIONS:   BONDS   PAYABLE; 

SINKING  FUND 

Forms  of  Corporate  Obligations.— A  corporation  may  bor- 
row  money  in  a  number  of  ways  among  which  the  following 
are  typical: 

1.  Bank  credit. 

2.  Notes. 

3.  Bond  and  mortgage. 

4.  Bonds. 

If  Ihe  loan  is  of  a  small  amount,  or  is  to  extend  only  over 
a  short  period  of  time,  or  is  to  be  secured  from  a  relatively 
few  persons,  the  evidence  of  such   obligation  will  take 
usually  the  form  of  corporate  notes.     Although  the  cor- 
porate note  is  a  formal  promise  to  pay  money,  it  does  not 
have  to  be  executed  under  seal,  and,  usually,  it  will  run 
for  a  period  less  than  five  years.    If  the  loan  is  large  in 
amount  and  is  to  be  obtained  in  one  lump  sum,  the  evi- 
dence  of  such  obligation  may  assume  the  form  of  a  bond 
and  mortgage  on  real  property.    The  bond  and  mortgage, 
as  a  rule,  will  involve  only  two  parties,— the  mortgagor 
(the  borrower)  and  the  mortgagee  (the  lender) ;  usually, 
it  will  run  for  a  period  less  than  five  years. 
Finally,  if  the  loan  is  large  in  amount,  and  is  to  extend  over  a 
long  period  of  time,  the  evidence  of  such  obligation,  usually 
will  take  the  form  of  a  bond  issue.    A  corporate  bond  issue  may 
be  participated  in  by  a  large  number  of  investors;  in  fact,  this 
feature  is  distinctive  of  bond  issues.    A  bond  must  be  executed 
under  seal.    It  may  be  secured,  and  usually  is,  as  to  repayment 
of  principal  and  the  payment  of  interest,  by  a  lien  or  mortgage 
on  specified  property  and,  at  tiines,  by  the  creation  of  a  sinking 
fund  held  in  trust  to  safeguard  its  redemption  at  maturity     A 
bond  issue  may  run  from  five  years  to  fifty  years  or  more.    The 

256 


CORPORATE  OBLIGATIONS;  BONDS  PAYABLE  257 

issuing  corporation  usually  sells  its  bonds  to  the  public  through 
bankers  or  brokers. 

One  of  the  functions  of  a  corporation  is  to  issue  bonds.  A 
government,  likewise,  has  this  privilege,  only  there  is  a  marked 
difference  between  the  two  types.  A  government  issues  and 
sells  its  bonds  only  because  the  public  has  faith  in  its  stability; 
on  the  other  hand,  a  corporation  issues  bonds,  generally,  because 
the  buying  public  knows  they  are  a  lien  against  specific  tangible 
assets  which  it  feels  are  sufficient  to  guarantee  repayment. 
Therefore,  a  corporate  bond  is  an  obligation,  a  promise,  under 
seal,  admitting  an  indebtedness  coupled  with  an  agreement  that 
the  indebtedness  will  be  repaid  at  a  specified  time  and  that  in- 
terest thereon  will  be  paid  at  an  agreed  rate  at  periodic  intervals. 
In  other  words,  a  corporate  bond  is  a  future  obligation,  sold  as  of 
the  present,  bearing  interest  until  date  of  maturity.  The  amoimt 
of  the  obligation  of  a  bond  issue  is  the  par  value  of  the  bonds 
plus  the  interest  that  must  be  paid  upon  periodical  recurring 
dates.  The  former  is  a  Balance  Sheet  item,  whereas,  the  latter 
is  a  Profit  and  Loss  Statement  item. 

A  bond  differs  from  an  ordinary  note  in  that  its  character  is 
more  formal  and  its  terms  more  specific.  This  is  because  a  bond 
runs  for  a  longer  time  than  a  note  and,  therefore,  must  be  safe- 
guarded carefully.  A  note  expires  within  a  short  time  and 
during  its  term  the  condition  of  the  issuing  company  is  not  apt 
to  change  materially;  in  the  case  of  a  bond  issue,  the  condition 
of  the  issuing  company  will  change  materially  during  the  life  of 
the  obligation.  The  form  of  a  bond,  so  long  as  it  conforms  to 
certain  particulars,  is  more  a  matter  of  choice  than  anything 
else. 

The  Trustee  and  the  Trust  Agreement.— As  a  rule,  to 
secure  the  payment  of  these  bond  obligations,  the  issuing 
corporation  executes  a  mortgage  or  trust  deed,  a  collateral  trust 
agreement,  in  favor  of  a  trustee  or  trustees,  usually  a  trust  com- 
pany, to  be  held  by  the  latter  as  security  for  the  payment  of 
the  bonds  at  maturity  and  for  the  payment  of  the  interest  as 
called  for  at  stated  periods. 

If  the  bonds  are  not  paid  at  maturity,  or  if  the  payment  of 
interest  is  defaulted  upon  any  interest  payment  date,  the  trustee 
or  trustees  will  foreclose  the  mortgage,  or  sell  the  securities,  as 


258 


ADVANCED  ACCOUNTING 


the  case  may  be,  in  accord  with  the  terms  and  conditions  of 
the  trust,  for  the  benefit  of  the  bondholders.  The  one  existing 
possibility,  aiming  toward  the  non-carrying  out  of  the  above 
proviso,  is  that  the  corporation  may  be  able  to  place  another 
bond  issue  on  the  market  successfully  and  with  the  money  re- 
ceived therefrom  retire  the  first  outstanding  obligation. 

Trustee's  Certificate.— The  trust  deed  or  mortgage  contains 
usually  a  provision  that  a  bond  cannot  come  under  its  protec- 
tion until  the  trustee  has  authenticated  it.  Therefore,  to  each 
bond  a  trustee's  certificate  usually  will  be  attached,  properly 
executed,  before  the  bond  is  handed  over  to  the  purchaser. 

Compliance  With  Statutes.— The  issuance  of  bonds  must  be 
made  in  accord  with  statutory  requirements.  Extracts  from  the 
Stock  Corporation  Law  of  New  York,  Art.  2,  covering  the 
issue  of  bonds,  are  as  follows: 

1.  In  addition  to  the  powers  conferred  by  the  general  corporation 
law,  every  stock  corporation  shall  have  the  power  to  borrow  money 
.  .  .  .  ;  and  it  may  issue  and  dispose  of  its  obligations  for  any 
amount  so  borrowed,  and  it  may  mortgage  its  property  and  fran- 
chises to  secure  the  payment  of  such  obligations,  or  of  any  debt 
contracted  for  said  purposes. 

2.  Every  such  mortgage,  except  purchase-money  mortgages  and  mort- 
gages authorized  by  contracts  made  prior  to  May  first,  eighteen 
hundred  and  ninety-one,  shall  be  consented  to  by  the  holders  of 
not  less  than  two-thirds  of  the  capital  stock  of  the  corporation,  or, 
if  the  corporation  is  authorized  to  issue  shares  without  nominal 
or  par  value,  then  by  the  holders  of  two-thirds  of  the  total  number 
of  shares  issued  and  outstanding,  which  consent  shall  be  given  either 
in  writing  or  by  vote  at  a  special  meeting  of  the  stockholders  called 
for  that  purpose,  upon  the  same  notice  as  that  required  for  the 
annual  meetings  of  the  corporation  that  such  consent  was  given  hy 
the  stockholders  in  writing,  or  that  it  was  given  by  vote  at  a  meet- 
ing  as  aforesaid,  shall  be  subscribed  and  acknowledged  by  the  presi- 
dent or  a  vice-president  and  by  the  secretary,  or  an  assistant  secre- 
tary, of  the  corporation,  and  shall  be  filed  and  recorded  in  the 
office  of  the  clerk  or  register  of  the  county  wherein  the  corporation 
has  its  principal  place  of  business. 

The  mortgage  or  trust  deed  should  contain  a  clause  to  the 
end  that  the  provisions  mentioned  above  have  been  complied 
with.  And  so  long  as  the  certificate  mentioued  remains  on 
record  uncancelled,  it  is  final  evidence  of  the  truth  of  the  state- 


I 


CORPORATE  OBLIGATIONS;  BONDS  PAYABLE  259 

ment  of  the  clause  above  referred  to.    This  is  of  considerable  im- 
portance, at  least,  to  bond  purchasers. 

Bond  Signatures.— The  body  of  a  bond  usually  is  signed  by 
the  president  or  vice-president,  and  by  the  secretary  or  as- 
sistant secretary.  The  corporate  seal  is  attached  also,  attested 
by  the  signature  of  either  the  secretary  or  the  assistant-secre- 
tary. 

The  coupons  attached  to  a  bond  may  or  may  not  actually  be 
signed.  If  the  issue  be  a  small  one,  the  treasurer  actually  may 
sign  each  coupon;  if  the  issue  be  a  large  one,  such  actual  sign- 
ing may  be  impossible.  In  such  case,  the  engraved  signature 
of  the  treasurer  will  be  used. 

Listing  Bonds  on  the  Exchange.— Bonds  may  be  listed  upon 
the  New  York  Stock  Exchange  provided  certain  requirements 
have  been  met.  All  documents  necessary  to  establish  the  fact 
that  the  issue  has  been  duly  authorized  and  issued  must  be 
filed,  and  the  rules  of  the  Exchange  covering  form,  engraving, 
denomination,  etc.,  must  be  observed. 

Unissued  Bonds  and  Treasury  Bonds.— The  liability  on 
account  of  a  bond  issue  is  set  out  in  one  account  upon  the 
financial  records,  such  account  being  considered,  generally,  as 
a  capital  liability.  An  authorized  issue  of  bonds  may  be  sold 
piecemeal  in  various  lots,  or  they  may  be  disposed  of  in  one  lot. 
Where  merely  authorized,  and  not  actually  signed  and  sealed, 
it  would  be  perfectly  correct  to  make  no  record  at  all  in  the  ac- 
counts to  cover  the  issue.  Some  accountants  will  list  unissued 
bonds  as  an  asset  upon  the  Balance  Sheet,  and  others  will  deduct 
their  amount  from  the  authorized  issue;  the  latter  practice 
seems  preferable  in  that  the  right  to  issue  is  shown  distinctly. 

The  importance  of  distinguishing  between  unissued  bonds  and 
treasury  bonds,  ordinarily,  is  not  of  much  consequence,  as  bonds 
may  be  issued  for  less  than  par.  But  it  would  seem  that  where 
bonds  have  been  signed  and  sealed,  although  not  actually  de- 
livered, they  should  be  recorded  otherwise  than  as  unissued 
The  act  of  signing  and  sealing  makes  at  least  one  corporate 
officer  specifically  answerable  for  their  proper  custody  if  any 
of  these  bonds  should  be  misappropriated,  and  fall  into  the  hands 
of  an  innocent  purchaser  for  value,  the  latter  would  have  an 
enforcible  claim  against  the  corporation.     Therefore,  it  would 


260 


ADVANCED  ACCOUNTING 


seem  proper  to  record  corporate  bonds  authorized,  signed,  and 
sealed,  as  treasury  bonds,  to  provide  for  their  being  handled  with 
great  care.  Likewise,  reacquired  bonds  may  be  considered  as 
treasury  bonds;  these,  usually,  are  sinking  fund  securities  and 
will  be  discussed  when  that  topic  is  considered.  Transportation 
companies,  under  the  rulings  of  the  Interstate  Commerce  Com- 
mission, are  required  to  classify  authorized  bonds,  signed,  and 
sealed  by  the  mortgage  trustee,  as  working  ansets. 

Entries  Covering  the  Issue  of  Bonds.— The  entries  covering 
the  issuance  of  bonds,  and  certain  practices  relative  thereto,  may 
be  summarized  about  as  follows: 

1.  Regular  issue.     Hereunder,  two  methods  of  booking  are 

available.    Assume  an  authorized  issue  of  $500,000.00,  of 

which  $300,000.00  are  sold  for  cash,  at  par,  balance  unsold 

being  unissued: 

a.  First  method: 

$300,000.00 


$300,000  00 


$500,000.00 


$500,000  00 


$300,000  GO 


Dr.  Cash, 

Cr.  Bonds  Payable, 

Hereunder,  no  entry  is  made 
until  cash  is  received. 

b.  Second  method: 

i.  Dr.  Unissued  Bonds, 
Cr.  Bonds  Payable, 

To  record  authorized  issue. 
ii.  Dr.  Cash,  $300 ,  000 .  00 

Cr.  Unissued  Bonds, 

To  record  cash  collected. 
The  second  method  seems  preferable  to  the  first  one  for 
reasons  already  advanced  favoring  the  formal  method  of 
recording  a  capital  stock  issue:  That  a  complete  history 
of  the  transaction  is  available  from  a  reading  of  the  ac- 
counts. 

2.  Issue  upon  an  instalment  basis.  Assume  for  the  above 
problem  that  payment  was  made  in  two  equal  instalments. 
As  in  the  case  of  capital  stock,  the  bonds  should  not  be 
issued  until  the  subscriptions  are  fully  paid: 

a.  Dr.  Unissued  Bonds,  $500 ,  000 .  00 

Cr.  Bonds  Payable,  $500 ,000  00 

To  record  authorized  issue. 

b.  Dr.  Bond  Subscribers,  $300,000.00 

Cr.  Bond  Subscriptions,  $300,000  00 

To  record  subscriptions  taken. 


CORPORATE  OBLIGATIONS;  BONDS  PAYABLE  261 


$150,000.00 


$150,000.00 


$150,000  00 


$150,000.00 


$150,000  00 
$150,000.00 


$150,000  00 
$150,000.00 


$150,000.00 


$150,000  00 


c.  Dr.  Instalment  No.  1, 

Cr.  Bond  Subscribers, 

To  record  instalment  of  50 
per  cent  now  due. 

d.  Dr.  Cash, 

Cr.  Instalment  No.  1, 

To  record  cash  received  upon 
instalment  No.  1;  Cash  Book 
entry. 

In  place  of  entries    (c)    and    (d)    above,  the   following 
might  have  been  made: 

Dr.  Cash  (Instalment  No.  1), 
Cr.  Bond  Subscribers, 

e.  Dr.  Instalment  No.  2, 

Cr.  Bond  Subscribers, 

To  record  [instalment  of  50 
per  cent  now  due. 

f.  Dr.  Cash, 

Cr.  Instalment  No.  2, 

To  record  cash  received  upon 
instalment  No.  2;  Cash  Book 
entry. 

In  place  of  entries  (e)  and  (f)  above,  the  following  entry 
might  have  been  made: 

Dr.  Cash  (Instalment  No.  2),  $150,000.00 

Cr.  Bond  Subscriptions,  $150,000.00 

g.  Dr.  Bond  Subscriptions,  $300,000.00 

Cr.  Unissued  Bonds,  J300 ,  000 .  00 

To  record  issuance  of  bonds. 

3.  Bond  premium  and  discount.  Bond  premium  and  discount 
should  not  be  handled  similarly  to  premium  and  discount 
on  capital  stock.  Bond  premium  is  in  the  nature  of  a  lia- 
bility (a  deferred  credit) ,  whereas,  bond  discount  is  in  the 
nature  of  an  asset  (a  deferred  debit).  (But  see  section, 
post:  Bond  Premium,  Discount,  and  Expense.)  The  Inter- 
state Commerce  Commission  requires  that  bond  premium 
be  carried  upon  the  Balance  Sheet  as  a  deferred  income 
credit,  and  that  bond  discount  be  shown  thereon  as  a  de- 
ferred charge. 

4.  Expenses  of  floating  a  bond  issue.  These  may  be  shown  in 
any  one  of  the  following  accounts: 

a.  Bond  Issue  Expense  account. 

b.  Underwriting  Expense  account. 


262 


ADVANCED  ACCOUNTING 


c.  Bond  Discount  and  Expense  account.  The  use  of  this 
account  contemplates  combining  the  discount  and  the 
issuing  expense  under  one  caption.  It  would  seem  not 
to  be  in  error  to  use  such  an  account  where  the  expense 
is  to  be  amortized  over  the  future  years. 

d.  Organization  Expense  account.  The  use  of  this  account 
does  not  seem  proper. 

5.  Issuance  of  special  types  of  bonds: 

a.  Collateral  trust  bonds.  Precede  the  opening  entries  by 
an  entry  under  which  the  following  results,  relative  to 
the  amount  of  the  collateral: 

Dr.  Pledged  Investments,  $  ff 

Cr.  Investments,  $  ^ 

b.  Equipment  trust  bonds: 

Dr.  Leased  Equipment,  $  ff 

Cr.  Equipment  Trust  Bonds,  $  ^ 

To  record  total  issue. 
Dr.  Equipment  Trust  Bonds,  %  ff 

Cr.  Cash,  |  ^ 

To  record  each  equal  instalment 
paid  off. 
Dr.  Equipment,  $  ff 

Cr.  Leased  Equipment,  $  ^ 

To  record  taking  over  the  equip- 
ment with  full  title  when  a  release 
has  been  secured  after  payment 
of  the  last  instalment  due. 

Illustrative  Problem  and  Solution. 

Problem. — A  corporation  issued  First  Mortgage  Bonds  bearing  interest  at 
5  per  cent,  dated  January  1,  1917,  to  subscribers  at  $125.00  for  each  bond, 
par  value  $100.00.  The  bonds  are  to  be  paid  for  in  three  instalments: 
$25.00  on  February  1;  $50.00  on  March  1;  and  $50.00  on  April  1.  The 
February  1,  and  March  1  instalments  have  been  paid  and  the  proper 
entries  made  on  the  Cash  Book.  You  are  called  in  to  formulate  the  Journal 
entries  on  the  two  instalments.  How  would  you  make  them?  There 
were  issued  and  sold  $100,000.00  par  value.     (C.  P.  A.) 

Solution. — The  above  problem  is  simple  in  the  extreme,  but  illustrates 
fairly  well  what  has  been  covered  above  in  the  last  section.  Note  the 
fact  that  the  entries  have  been  made  upon  the  Cash  Book  in  due  and  proper 
form,  and  that  all  that  is  required  are  the  Journal  entries.  However,  for 
illustrative  purposes,  all  the  entries  are  given,  but  those  not  required-  have 
been  thus  earmarked;  the  entries  are  in  Journal  form: 


CORPORATE  OBLIGATIONS;  BONDS  PAYABLE  263 


I 


$100,000.00 


$100,000.00 
25,000.00 


$25,000.00 


$25,000.00 


(1) 
Date  should  be  that  on  which  issue  authorized 
Unissued  First  Mortgage  5  per  cent  Bonds,         $100 ,  000 .  00 
To — First  Mortgage  5  per  cent  Bonds, 
To  record  authorized  issue. 

(2) 
January  1,  1917 
(On  assumption  that  this  was  subscribers  date) 
Bond  Subscribers, — First  Mortgage  5  per  cent 

^o<^s,  $125,000.00 

To— Bond   Subscriptions — First  Mortgage 
5  per  cent  Bonds, 
Bond  Premium, 

To  record  subscriptions  to  above  issue. 

(3) 
February  1,  1917 
Instalment  No.  1 — First  Mortgage  5  per  cent 
Bonds, 
To — Bond     Subscribers — First     Mortgage 
5  per  cent  Bonds, 

To  record  first  instalment  due  this 
date,  representing  20  per  cent  of  bond 
subscriptions. 

(4) 

Dates  not  known 

(Entry  not  required;  being  on  Cash  Book) 

^^^^  $25,000.00 

To — Instalment    No.    1 — First    Mortgage 

5  per  cent  Bonds, 

(5) 
March  1,  1917 
Instalment  No.  2 — First  Mortgage  5  per  cent 
Bonds, 

To — Bond     Subscribers — First     Mortgage 

6  per  cent  Bonds, 

To  record  second  instalment  due  this 
date,  representing  40  per  cent  of  bond 
subscriptions. 

(6) 
Dates  not  known 
(Entry  not  required;  being  on  Cash  Book) 
Similar  to  (4)  above,  except  as  to  amount. 

Payment  of  Bond  Interest.— The  usual  handling  of  pay- 
ments covering  bond  interest  is  considered  hereunder.  In  dis- 
cussing bond  interest,  two  points  come  to  mind: 

1.  Considerable  already  has  been  stated  hereon  in  former  sec- 
tions. Therefore,  a  detailed  discussion  appears  unnecessary 
at  this  point. 


$25,000.00 


$50,000.00 


$50,000.00 


264 


ADVANCED  ACCOUNTING 


2.  Variations  in  procedure  are  apparent  when  one  considers 
different  classes  of  bonds.  Therefore,  it  seems  advisable  to 
discuss  briefly  the  subject  of  interest  in  connection  with 
certain  different  types  of  issues.  The  following  is  deemed 
sufficient  relative  thereto: 

a.  Registered  bonds.  The  interest  when  due  would  be  sent 
to  the  bondholders  either  by  the  fiscal  agent  or  by  the 
company  treasurer.  Since  bond  interest  accrues  day  by 
day,  it  would  be  correct  accounting  to  provide  therefor 
by  proper  monthly  entries  so  that  correct  monthly  state- 
ments may  be  prepared: 

i.  Bond  Interest,  $  ^ 

To — Bond  Interest  Accrued,  $  ^ 

To  record  monthly  accrual, 
ii.  Bond  Interest  Accrued,  $  ^ 

To — Cash,  I  ^ 

To  record  semi-annual  (quar- 
terly or  yearly)  payments. 
An  alphabetical  list  of  the  holders  of  registered  bonds 
who  are  entitled  to  receive  interest  checks  should  be  pre- 
pared as  of  each  interest-paying  date. 

b.  Coupon  bonds.  The  same  procedure  as  shown  above 
apparently  would  answer  for  coupon  bonds.  Since  many 
coupons  are  unredeemed  at  the  end  of  each  period,  a 
mere  booking  upon  the  cash  payment  basis  would  seem 
incorrect. 

c.  Treasury  bonds.  Interest  upon  treasury  bonds  requires 
no  entry  unless  they  are  held  by  a  trustee  under  a  pro- 
vision relating  to  the  sinking  fund  that  he  is  to  receive 
all  interest  and  invest  same. 

d.  Guaranteed  bonds.  Nothing  unusual  will  occiu-  relative 
to  these  bonds  unless  the  issuing  company  defaults  in 
the  payment  of  interest;  in  such  event,  the  guaranteeing 
company  must  make  payment.  When  this  occurs,  an 
inter-company  transaction  results  (see  post:  Chap.  13). 

i.  Entry  on  books  of  guaranteeing  company: 
Advances  to  Subsidiaries,  $  ^ 

To— Cash,  $  ^ 

ii.  Entry  on  books  of  defaulting  company: 

Bond  Interest,  |  ^ 

To — ^Advances  from  Parent  Company,  f  ^ 


CORPORATE  OBLIGATIONS;  BONDS  PAYABLE  265 

e.  Income  bonds.  If  these  are  considered  as  being  in  the 
same  class  with  preferred  stock,  as  seems  to  be  the  case, 
the  interest  thereon  should  be  booked  similarly  to  the 
entries  required  when  dividends  are  declared.  If,  on  any 
interest-paying  date,  profits  are  sufficient  to  make  pay- 
ment of  the  contingent  interest  amount  due,  the  follow- 
ing entries  would  be  in  order: 

i.  Interest — Income  Bonds,  $  ^ 

To — Interest  Payable — Income  Bonds,  $  ff 

To    record    interest    declared 
payable, 
ii.  Interest  Payable — Income  Bonds,  $  ^ 

To — Cash,  I  ^ 

To  record  interest  paid. 

Bond  Interest  and  Construction.—The  various  charges 
arising  during  periods  of  construction,  under  the  rulings  of  the 
Interstate  Commerce  Commission  and  the  Public  Service  Com- 
mission of  New  York,  may  be  capitalized.  Therefore,  items  like 
bond  interest  and  bond  discount  may  be  thus  capitalized  as  well 
as  interest  on  loans  and  construction  expenses. 

In  booking  these  items,  the  following  procedure  would  be 
illustrative : 

1.  As  these  items  currently  accumulate,  charges  to  cover 
would  be  made  to  proper  accounts: 

a.  Bond  Interest. 

b.  Bond  Discount. 

c.  Interest  on  Loans. 

d.  Construction  Expenses. 

2.  Periodically,  as  yearly,  or  when  the  construction  is  com- 
pleted, transfers  would  be  made  from  the  above  accounts, 
to  either: 

a.  Construction  account,  or 

b.  Plant  and  Equipment  account. 

Bond  Premium,  Discount,  and  Expense.— The  Bond 
Premium  account  is  presumed  to  hold  the  amount  in  excess  of 
par  value  realized  from  a  sale  of  bonds.  Briefly,  its  amount 
should  be  written  off  over  the  life  of  the  bonds.  The  account 
with  Bond  Discount  and  Expense  is  supposed  to  hold  the  cost 
of  an  issue  of  bonds;  all  expenses  incident  to  a  bond  issue  as 
well  as  the  discount  involved  when  bonds  are  sold  below  par. 


i 


266 


ADVANCED  ACCOUNTING 


f 


One  account  may  be  used  to  gather  these  charges,  as  shown 
above,  or  separate  accounts  may  be  kept  with  Bond  Discount 
and  Bond  Expense.  Bond  discount  is  considered  as  being  an 
increase  in  the  actual  amount  of  interest  paid  which,  however, 
should  be  written  off  over  the  life  of  the  bonds. 

The  premium  received  or  the  discounts  allowed  upon  the  sale 
of  bonds  is  considered  as  a  deduction  from,  or  an  addition  to, 
the  interest  paid  on  the  bonds: 

1.  In  case  of  discount,  the  borrower  is  said  to  pay  for  two 
things: 

a.  Interest  for  the  use  of  money. 

b.  Discount,  for  the  use  of  money. 

2.  In  case  of  premium,  the  principal  sum  borrowed  exceeds 
par  and,  since  the  excess,  or  premium,  need  not  be  repaid 
at  maturity,  it  amounts  to  a  deduction  from  interest. 

Because  of  the  above,  most  accountants  agree  that  the  pre- 
mium or  discount  should  be  written  off  over  the  life  of  the  bonds 
in  order  that  each  accounting  period  may  show  the  accurate  or 
true  cost  of  carrying  the  issue.  The  writing  off  is  accomplished 
either  by  crediting  or  charging  a  proportionate  amount  or  part 
to  the  Interest  account,  and  thence  from  here  to  the  Profit  and 
Loss  account,  at  the  end  of  each  fiscal  period. 

Three  methods  of  writing  off  are  followed,  the  first  of  which 
is  not  in  conformity  with  the  principle  indicated  in  the  last 
paragraph  above: 

1.  Write  the  amount  off  immediately  either  to  Profit  and  Loss 
or  to  Surplus  accounts.  Since  the  true  cost  of  carrying  the 
issue  cannot  be  shown  hereunder,  the  method  is  in  error. 

2.  Write  the  amount  off  in  equal  instalments  over  the  life  of 
the  issue.  Apparently,  this  method  is  in  accord  with  the 
principle  advanced  above;  but  as  a  matter  of  fact,  it  is  in 
error  for  the  same  reason  as  the  first  method.  It  does  not 
recognize  the  effective  rate  of  interest.  It  is  known  as  the 
"straight  line"  method  and,  from  a  practical  point  of  view, 
is  used  considerably. 

3.  The  "effective  rate"  method  seems  to  be  the  best  one  thus 
far  advanced  for  writing  off  bond  premium  or  discount. 
The  effective  rate  is  calculated  upon  the  amount  actually 
received,   rather  than  upon   the   par   value.     The   actual 


CORPORATE  OBLIGATIONS;  BONDS  PAYABLE 


267 


amount  of  interest  paid  is  charged  to  the  Bond  Interest 
account.    Then  the  procedure  varies  as  under: 

a.  If  bonds  are  sold  at  a  premium.  The  difference  between 
the  effective  (the  market  rate  of  interest)  and  the  nomi- 
nal (amount  actually  paid)  interest  rates  is  charged 
periodically  to  Bond  Premium  account  and  credited  to 
Bond  Interest  account. 

b.  If  bonds  are  sold  at  a  discount.  The  difference  between 
the  effective  and  the  nominal  interest  rates  is  charged 
periodically  to  Bond  Interest  account  and  credited  to 
Bond  Discount   (and  Expense)   account. 

This  method  scientifically  writes  off  the  premium  or  dis- 
count over  the  life  of  the  bonds.  The  method  makes  use 
of  the  amortization  principle. 
Sinking  Fund. — A  fund  always  should  represent  an  asset.  A 
sinking  fund  should  be  created  by  assets  in  the  proper  converted 
form  being  set  aside  for  the  purpose  for  which  the  fund  was 
established.  Ordinarily,  such  purpose  will  be  the  retirement  of 
a  bond  issue.  Payments  are  made  into  the  fund  usually  at 
regular  recurring  intervals  by  more  or  less  regular  amounts,  as 
monthly,  quarterly,  semi-annually,  or  annually.  These  pay- 
ments either  are  placed  in  a  bank,  or  are  used  for  the  purchase 
of  gilt-edged  securities  usually  by  depositing  with  a  trustee  for 
the  bondholders;  in  either  instance,  the  fund,  as  booked,  will 
consist  of  cash  or  of  cash  and  securities.  Naturally,  increases 
in  the  fund,  in  part,  will  consist  of  interest,  and  perhaps  divi- 
dends, collected  upon  the  fund  principal. 

The  liability  for  the  payment  of  which  the  sinking  fund  is 
created  and  accumulated  may  vary  as  to  type,  about  as  fol- 
lows: 

1.  It  may  be  payable  in  one  amount  at  the  maturity  date  of 
the  bond  issue. 

2.  It  may  be  payable  in  yearly  instalments,  the  bonds  to  be 
retired  thereunder  being  determined  by  the  drawing  of  the 
bond  numbers. 

The  sinking  fund  procedure  may  or  may  not  be  governed  by 
the  terms  of  a  mortgage  agreement  which  secures  an  issue  of 
bonds.  In  other  words,  the  fund  accumulation  may  or  may  not 
bear  a  relationship  to  corporate  profits: 


268 


ADVANCED  ACCOUNTING 


1.  Without  reference  to  profit.  Hereunder,  general  assets  are 
converted  and  set  aside  by  a  general  procedure  in  accord 
with  a  general  plan  under  which  the  liability  in  question 
eventually  will  be  redeemed.  The  mortgage  will  not  pro- 
vide for  the  creation  of  such  a  fund  from  income  assets. 

2.  With  reference  to  corporate  profit.  Hereunder,  the  sink- 
ing fund  procedure  is  made  necessary  by  the  terms  of  a 
mortgage  agreement  securing  a  bond  issue: 

a.  Where  the  capital  plant  either  is  subject  to  conditions 
that  will  reduce  the  longevity  thereof,  or  is  diminished 
on  account  of  operations: 

i.  The  usual  industrial  company  is  more  or  less  non- 
permanent, 
ii.  A  mining  company,  or  one  of  similar  type,  will 

exhaust  its  capital  plant  over  a  period  of  years. 
Hence,  it  is  usual,  when  floating  a  bond  issue,  to  have 
the  mortgage  contain  a  provision  requiring  the  accumu- 
lation of  a  fund  out  of  which  the  bond  principal  will  be 
paid  at  maturity  because,  by  such  provision,  it  is  thought 
the  bond  issue  will  sell  better  and  a  higher  price  is  se- 
curable. 

b.  Where  the  capital  plant  remains  more  or  less  permanent, 
and  the  belief  is  prevalent  that  such  plant  will  be  more 
valuable  at  the  expiration  of  the  bond  issue  term  than  at 
present.  Hereunder,  a  bond  issue  may  be  floated  without 
reference  to  any  sinking  fund  provision ;  a  railroad  would 
be  an  example  of  this  type  of  activity. 

The  provision  that  a  sinking  fund  shall  be  created  from  in- 
come assets  is  the  usual  requirement  of  a  corporate  mortgage 
backing  a  bond  issue,  inasmuch  as: 

1.  Corporate  assets  are  conserved. 

2.  The  liability  will  be  paid  from  earned  assets,  not  from  those 
comprising  a  portion  of  the  assets  secured  through  incur- 
ring the  liability. 

3.  Profits  cannot  be  distributed  until  after  the  yearly  con- 
tribution to  the  sinking  fund  has  been  made;  hence,  a 
tendency  toward  a  riotous  life  cannot  become  full  grown 
without  first  providing  the  means  for  taking  care  that  the 
liability  will  be  paid  when  due. 


CORPORATE  OBLIGATIONS;  BONDS  PAYABLE 


269 


4.  Upon  the  completion  of  the  sinking  fund  procedure,  there 
will  be  on  hand  undistributed  profit  in  the  requisite  amount 
for  the  use  originally  agreed. 

Sinking  Fund  Trustee. — The  terms  of  a  mortgage  agreement 
securing  an  issue  of  bonds  require,  generally,  that  payments  into 
the  sinking  fund  be  made  through  the  mediimi  of  a  trustee  who 
is  given  the  duty  of  taking  charge  of  the  fund  for  the  benefit  of 
both  the  bondholders  and  the  corporation.  The  trustee  thus 
designated,  usually,  is  a  trust  company,  and  this  latter  acts  as 
such  for  a  compensation  based  upon  a  percentage  of  the  funds 
handled. 

By  virtue  of  the  mortgage  agreement  requirements,  above  in- 
dicated, the  asset  fund  thus  desired  is  removed  from  the  con- 
trol of  the  corporation  under  which  its  availability  for  the 
specific  purpose  of  eventually  meeting  a  bond  obligation  might 
be  jeopardized  by  the  incoming  of  general  creditors'  liens.  In 
other  words,  corporate  funds,  not  specifically  pledged,  cannot  be 
set  aside  for  the  use  of  a  particular  class  of  creditors. 

In  attempting  to  discuss  the  general  variations  governing 
sinking  fund  entries,  it  may  not  be  amiss  at  this  point  to  re- 
capitulate two  or  three  principles  which  have  been  set  out  above: 

1.  A  sinking  fund  may  be  created  without  regard  to  profits. 
If  so,  the  fund  account  would  be  charged  and,  say,  the 
Cash  account  credited.  Increases  in  this  fund  on  account 
of  interest  earnings  would  be  credited  to  Profit  and  Loss 
account,  and  be  charged  to  the  fund  account  when  col- 
lected. 

2.  A  sinking  fund  may  be  created  with  regard  to  profits,-^ut 
of  assets  secured  from  profits.  This  requirement  should 
operate  about  as  follows: 

a.  A  certain  amount  should  be  reserved  from  profits,  the 
effect  of  which  will  be  to  credit  a  profit  appropriation 
account,  as  Sinking  Fund  Reserve  account,  and  to  charge 
Surplus  (an  undivided  profits  account)  account.  The 
balance  in  this  reserve  account  indicates  the  amounts 
held  back  from  profit  for  sinking  fund  purposes. 

b.  The  fund  account  then  is  debited  with  the  cash  or  other 
assets  sent  into  it  from  time  to  time.  If  a  trustee  is  to 
take  over  the  custodianship  of  the  sinking  fund,  the 


270 


ADVANCED  ACCOUNTING 


|i  i' 


trustee  will  have  turned  over  to  him  an  amount  of  cash 
equal  to  the  appropriation  from  surplus,  by  means  of 
an  entry  charging  an  account  with  the  trustee  and 
crediting  Cash  account. 

Hence,  if  the  booking  be  done  properly,  the  amount 

of  the  sinking  fund,  as  a  charge,  should  be  in  agreement 

with  the  amount  of  the  reserve,  as  a  credit. 

The  trustee  may  have  authority  to  invest  the  sinking  fund  in 

gilt-edge  securities,  or  he  may  be  required  only  to  hold  the  cash 

on  hand  on  deposit.    If  securities  are  purchased,  these  latter,  at 

least   in   part,   may    consist   of   the    corporation's    own   bonds. 

Hence,  it  is  possible  that  the  fund  will  consist  in  part  of  cash, 

and  in  part  of  bonds: 

1.  Cash. 

2.  Bonds. 

a.  Investment  securities. 

b.  Own  bonds. 

If  so,  when  the  Balance  Sheet  is  prepared,  it  would  seem 
to  be  good   accounting  to  differentiate  between  the  two 
classes  of  bonds. 
If  some  of  the  company's  own  bonds  are  held,  the  differentia- 
tion in  handling  may  be  set  out,  as  to  them,  as  under: 

1.  They  may  be  listed  upon  the  Balance  Sheet  either  among 
the  assets  or  as  a  deduction  from  the  total  bonds  payable 
outstanding;  the  latter  handling  seems  preferable  in  that 
treasury  bonds  are  assets  no  more  than  is  treasury  stock. 
The  above  assumes  the  sinking  fund  bonds  have  not  been 
cancelled. 

2.  If  the  sinking  fund  bonds  have  been  cancelled,  as  may  be 
done,  their  amount  may  be  handled  on  the  Balance  Sheet 
in  either  of  the  two  possible  following  ways: 

a.  Deduct  from  the  total  bonds  payable  outstanding. 

b.  Show  upon  the  Balance  Sheet  only  the  net  amount  of 
the  bonds  payable  outstanding.  This  procedure  is  be- 
lieved to  be  the  preferable  one  inasmuch  as  cancelled 
debts  ought  not  to  be  found  upon  the  Balance  Sheet. 

Where  the  sinking  fund  is  held  in  the  form  of  either  cash  on 
deposit  or  securities,  a  certain  amount  of  income  will  be  derived 
therefrom  from  time  to  time, — as  interest  uix)n  bank  balances, 


CORPORATE  OBLIGATIONS;  BONDS  PAYABLE  271 

and  interest   (or  dividends)    from  investments.     Such   income 
may  be  handled  in  one  of  three  possible  ways: 

1.  It  may  be  payable  to  the  corporation. 

2.  The  mortgage  agreement  may  provide  that  it  should  be 
turned  over  to  the  trustee  as  an  accretion  to  the  fund. 
Hereunder,  the  variation  in  booking  may  be  shown  as: 

a.  Charge  the  collecting  trustee,  and  credit, 
i.  Reserve  for  Sinking  Fund  account,  or 
ii.  Sinking  Fund  Income  account: 

(a)  The  amount  may  be  retained  herein  until  the 
trust  has  expired,  or 

(b)  The  amount  may  be  transferred  to  the  reserve 
account. 

3.  It  may  be  applied  as  a  deduction  against  the  next  sinking 
fund  instalment. 

In  any  event,  such  income  represents  a  special  profit. 
Premium  or  discount  on  bonds  that  have  been  purchased  for 
a  sinking  fund  may  be  handled  as  follows: 

1.  Write  off  immediately  to  Profit  and  Loss  account,  or 

2.  Distribute  same  (amortize  or  accumulate)  over  the  life  of 
the  purchased  bonds,  under  which  the  amount  thus  dis- 
tributed will  affect  the  interest  return.  This  method,  natur- 
ally; is  preferable  to  the  first  one. 

Likewise,  fluctuations  representing  a  profit  or  loss  on  the 
sale  of  securities  should  be  adjusted  through  the  account  of 
Sinking  Fund  Income. 
In  the  matter  of  bond  redemption,  certain  variations  appear 
which,  briefly,  may  be  indicated  about  as  follows: 

1.  Nothing  may  be  done  until  the  entire  issue  matures. 

2.  From  time  to  time  the  trustee  may  use  the  funds  under 
his  control,  go  out  into  the  market  and  purchase  therewith 
some  of  the  bonds  of  the  company  that  have  been  offered 
for  sale.  Naturally,  no  definite  policy  in  this  connection 
can  be  followed  inasmuch  as  it  is  uncertain  whether  any  of 
the  bonds  will  be  offered  for  sale  at  the  times  the  pur- 
chases are  desired.  This  point  has  been  mentioned  above 
already. 

3.  Certain  numbers  of  the  outstanding  bonds  may  be  retired 
annually  under  the  provisions  of  the  sinking  fund  indenture, 


I 

IN 


272 


ADVANCED  ACCOUNTING 


as  by  means  of  a  drawing  by  lot.     The  bond  numl)ers 
drawn  are  published,  after  which  interest  ceases  to  accrue 
upon  the  bonds  concerned,  the  trustee  secures  the   cash 
with  which  to  make  payment,  and  tlie  redemption  i)ro- 
ceeds  as  the  bonds  are  presented. 
In  view  of  the  fact  that  the  trustee  cannot  go  along  indefinitely 
holding  himself  ready  to  redeem  bonds  that  have  been  called, 
and  in  view  of  the  fact  that  at  times,  as  under  a  large  issue,  many 
bonds  will  not  be  presented  for  payment  within  a  reasonable 
period  of  time, — some  being  lost  or  the  owner  being  dead, — be- 
fore the  trustee  turns  over  the  cash  remaining  in  his  hands  un- 
used, he  will  require  a  bond  of  indemnity  to  be  furnished  by  the 
company  to  protect  him  against  loss  in  case  a  bond  is  pre- 
sented later  for  payment.    The  amount  of  this  indemnity  bond 
will  be  usually  twice  the  amount  of  the  greatest  possible  liability 
for  which  he  may  be  held. 

When  the  bond  liability  has  been  paid  off,  the  books  still  will 
retain  the  amount  or  the  account  of  Sinking  Fund  Reserve  repre- 
senting, if  correctly  set  up  from  actual  profits,  a  surplus  item 
which  either  may  be  appropriated  for  some  special  use  or  be  used 
for  purposes  of  stockholders'  distribution.  Hence,  a  reversing 
entry  charging  the  Reserve  account  and  crediting  Surplus  account 
would  be  in  order. 

To  summarize  the  portion  of  this  chapter  relative  to  handling 
maturing  bonds,  the  following  is  offered: 

1.  Convert  outside  securities  into  cash,  and  write  off  against 
the  Sinking  Fund  Income  account  any  differences  between 
the  book  values  and  the  amounts  realized  from  the  con- 
version. 

2.  Redeem  outstanding  bonds  from  cash  available. 

3.  Secure  indemnity  bond  double  the  amount  of  the  maximum 
liability  before  turning  any  remaining  cash  over  to  the 
company. 

4.  Cancel  any  treasury  bonds  in  the  sinking  fund,  and  close 
out  against  the  bonds  outstanding. 

5.  Turn  any  remaining  cash  over  to  the  regular  corporate 
cash  fund. 

6.  Clear  the  records  of  any  remaining  entries  relating  to  the 
bond  issue. 


lA 


t  \] 


CORPORATE  OBLIGATIONS;  BONDS  PAYABLE  273 

To  summarize  the  usual  sinking  fund  provisions  relative  to  a 
corporate  bond  issue,  as  covered  by  a  trust  deed,  and  to  show 
in  tangible  form  illustrative  Journal  entries  in  connection  there- 
with, the  following  is  offered: 

1.  Usual  sinking  fund  provisions: 

a.  Who  shall  be  the  trustees  of  the  sinking  fund. 

b.  What  amount  shall  be  set  aside  periodically  in  the 
sinking  fund,  monthly,  quarterly,  semi-annually,  or  an- 
nually. 

c.  How  the  money  in  the  sinking  fund  shall  be  invested  by 
the  trustee  or  trustees. 

2.  Pro-forma  entries  covering  sinking  provisions: 

a.  To  record  surplus  profit  set  aside  for  sinking  fund  pur- 
poses : 

Surplus  (or  Profit  and  Loss  Surplus),  $  ^ 

To — Reserve  for  Sinking  J'und,  $  i 

b.  To  record  periodical  transfer  of  cash  to  trustee  under 
agreement: 

Sinking  Fund  Trustee,  Cash  Account,  $  ^ 

To — Cash,  •  A 

c.  To  record  investments  for  sinking  fund  from  cash  avail- 
able, as  per  trustee's  report: 

Sinking  Fund  Trustee,  Securities  Account,     |  ^ 
Premium  on  Sinking  Fund  Securities,  $  ^ 

To— Sinking  Fund  Trustee,  Cash  Account,  $  ^ 

d.  To  record  expenses  and  compensation  of  trustee  as  per 
agreement: 

Sinking  Fund  Income  Account,  $  ^ 

To— Sinking  Fund  Trustee,  Cash  Account,  $  ^ 

This  entry  would  be  in  order  where  such  items  are 
chargeable  against  the  fund ;  but  where  these  items  are 
paid  directly  by  the  corporation,  as  may  be  done,  the 
entry  would  be: 

Sinking  Fund  Expenses,  $  ^ 

To— Cash, 

e.  To  record  income  collected  by  the  trustee: 


«  i 


Sinking  Fund  Trustee,  Cash  Account, 
To — Sinking  Fund  Income  Account, 

Premium  on  Sinking  Fund  Securities 
(pro  rata  amortization). 


u  ' 


b 


t  • 


I 


274  ADVANCED  ACCOUNTING 

f.  To   record   transfer   of   surplus   profit   for   purposes   of 
sinking  fund: 

Sinking  Fund  Income  Account,  $  i 

To — Reserve  for  Sinking  Fund,  $  j§ 

g.  To  record  cash  received  on  sale  of  sinking  fund  se- 
curities : 

Sinking  Fund  Trustee,  Cash  Account,  %  i 

To — Sinking  Fund  Trustee,  Securities 
Account,  S  ^ 

Adjustment  must  be  made,  also,  through  the  Sinking 
Fund  Income  account  for  the  loss  or  profit  entailed. 
Likewise,  the  purchase  premium  or  discount  involved 
must  be  considered, 
h.  To  record  purchase  of  own  bonds  for  sinking  fund: 

Sinking  Fund  Trustee,  Treasury  Bonds,  $  ^ 

To — Sinking  Fund  Trustee,  Cash  Account,  $  i 

i.   To  record  cancellation  of  these  treasury  bonds: 

First  Mortgage,  Sinking  Fund  Bonds,  %  i 

To — Sinking  Fund  Trustee,  Treasury 
Bonds,  $  ^ 

j.    To  record  payment  of  bonds  upon  maturity: 
First  Mortgage,  Sinking  Fund  Bonds,  $  i 

To — Sinking  Fund  Trustee,  Cash  Account,  $  i 

k.  To  record  cash  turned  over  to  company  by  trustee: 
Cash,  $  i 

To — Sinking  Fund  Trustee,  Cash  Account,  $  i 

1.    To  record  disposition  of  reserve  when  bond  issue  paid  up: 

Reserve  for  Sinking  Fund,  $  i 

To — Surplus  (or  otherwise  as  directors 

wish),  $  jif 

Illustrative  Problems  and  Solutions. — To  illustrate  further 
the  booking  of  bonds  and  sinking  funds,  two  C.  P.  A.  problems 
and  their  solutions  are  shown  below.  The  two  problems  selected 
are  fair  samples  of  those  encountered  in  that  in  each  one  cer- 
tain information  is  lacking;  and  this  makes  it  necessary  for  the 
student  to  determine  what  variation  from  accepted  procedure 
shall  be  adopted.  In  any  particular  case,  he  should  recognize 
the  usual  procedure  and  follow  this  to  a  conclusion  in  so  far 
as  is  possible,  if  a  variation  seems  necessary,  his  solution  and 
comment  should  be  such  that  the  reader  will  understand  exactly 
what  he  has  done,  and  why. 


CORPORATE  OBLIGATIONS;  BONDS  PAYABLE  275 

Problem  l-This  problem  is  simple  in  the  extreme,  but  information  i« 
lacking  a.  to  the  maturity  date  of  the  bond  issue.     Naturanrrerefor^ 

witho7''t-''  '"  '^^^^  *'^  amortization  principle  to  the  bond  "ni 
without  making  an  assumption;  the  making  of  such  an  assumotTon  I 
entirely  unnecessary.     This  being  the  ca^,  fhe  ex^ient  hTbeen  used 

c  mpletTI  but tr?-  '''•  TT  ^^  ^'^^  ^--n^-til  the  soluLnt 
completed,  but  indicating  just  where  the  reductions  thereof  occur 

bnl^'^^'^T  ''.^''**''''''^'^  ^  *^*^^  '^""^  «^  [1500,000.00  of  5  per  cent 
bonds  in    denommations  of  11,000.00  and  $500.00,  with  interest  ^avrble 

loTlI  Jo"  The""''  ^^'  '''''  ^';  f  ^^^  ^''^^  '^  -derwritrlrr;" 
1J18,  at  90     The  company  issued  the  bonds  for  the  underwriters  at  Q'i 
and  received  the  ca^h  in  payment  February  1,  1918      "''^^'™*''"  ^*  ^^' 

cJl.^^^Tl^^f^?'^^^'  ^^^*  "*^^''^  «*^^"  ^^  established  a  fund  to  be 
caJ^d  the  bond  sinking  fund,'  to  the  account  of  which  there  shaU  on^th^ 
thirty-first  day  of  December  of  each  year  be  carried  a  sum  equa^  to  7^ 

earned  to  the  account  of  the  said  fund,  the  company  shall  pay  theTnterest 
Shan  L  r       7^""'  'r'  ^^^""^^  ^"^'  '^^  *^«  balance  of  said  rne; 

In  January,  1919,  the  company  purchased  $10,000.00  of  its  bonds  at  97 
Ld:r98.        "'^""^'  ''^"-     '"^  '^^^^^  ''''^  '^^  market  prlfe  of  the 

Janua!;"l9To7  '"''  "'^  '^  ^""'^'  '^^'^  **^^  ^^^  -^^-«  ^-^  - 

sale  omL'  h^'Tl  """'T-  ^''  ""  '^'  transactions  from  the  date  of  the 
Tan^ary   1^^^^^^^^^  ^  ^'^^  ''^^^"'^"^  *^^  ^^^^^  ^-  the  sinking  fund  in 

c.  Show  trial  balance  after  posting  above  entries.     (C  P  A  ) 
J^^on  to  Problem  ..-The  solution  is  shown  by  „.eans\f  Journal 


(1) 
Date  not  known 
Unissued  5  per  cent  Bonds, 
To — 5  per  cent  Bonds  Payable, 
To  book  authorized  issue. 

(2) 
January  1,  1918 
Underwriters, 
To— Unissued  5  per  cent  Bonds, 

To  record  placement  of  entire  issue 
with  underwriters. 

(3) 

Unamortized  Bond  Discount, 

To — Underwriters, 

To  adjust  Underwriters  account  ta 
show  net  contract  sale  cost,  at  90. 


$500,000.00 


$500,000.00 


$500,000.00 


$500,000  00 


$50,000.00 


$50,000  00 


276 


ADVANCED  ACC0VNT1NG 


(4) 
February  1,  1918 


$475,000.00 


$475,000.00 


$35,000.00 


$35,000.00 


185,000.00 


Cash, 

To — Underwriters, 

To  record  cash  received  by  company 
on  behalf  of  underwriters 

(5) 
Underwriters,  $25 ,  000 .  00 

To— Cash,  .  $25,000.00 

To  record  payment  to  underwriters 
of  their  profit  from  selling  issue 
at  95. 

(6) 
December  31,  1918 

Bond  Sinking  Fund, 
To— Cash, 

To  record  annual  instalment  to 
sinking  fund  being  7  per  cent 
of  par  value  of  bonds. 

(7) 
January  1,  1918 

Bond  Interest, 

To— Bond  Sinking  Fund,  $25 ,  000 .  00 

To  record  payment  of  interest  due 
on  January  1,  1919,  out  of  sink- 
ing fund. 

The  next  entry  should  relate  to  the  proportional  extinguishment  of  the 
unamortized  bond  discount  However,  this  is  impossible  in  the  problem 
since  the  maturity  date  of  the  bond  issue  is  not  given.  One  might  make 
certain  assumptions  relative  thereto,  but  in  solving  C.  P.  A.  problems,  espe- 
cially in  an  examination,  the  contention  is  advanced  that  assumptions  should 
not  be  made  unless  absolutely  necessary  to  secure  a  solution  from  the  facts 
given.  One  may  well  point  out  an  existing  error  in  a  given  set  of  factai 
or  the  short-comings  thereof,  but  to  make  an  assumption  which,  at  best* 
may  be  extremely  far-fetched  does  not  seem  in  order. 

(8) 
January,  1919 

5  per  cent  Bonds  Payable, 

To — Unamortized  Bond  Discount 
Bond  Sinking  Fund, 

To  record  purchase  of  $10,000.00  par 
value  of  bonds  in  open  market  at  97, 
which  are  retired  and  cancelled. 
Since  exact  date  of  purchase  in  January 
is  not  known,  interest  accrued  must  be 
ignored. 


$10,000.00 


CORPORATE  OBLIGATIONS;  BONDS  PAYABLE 


277 


$300.00 
$9,700.00 


Bond  Interest,  (9) 

To— Unamortized  Bond  Discount, 

To  reduce  amount  of  discount  appli- 
cable to  the  $10,000.00  of  bonds  re- 
tired. If  it  had  been  possible  above  to 
adjust  the  Discount  account  when 
interest  was  paid  (entry  7),  the  amount 
adjusted  at  this  time  would  be  less 
than  $1,000.00  since  therefrom  should 
be  deducted  as  to  $10,000.00  par  the 
amount  already  charged  off. 

(10) 

n     J  o-  1  .      ^                     December  31,  1919 
Bond  Smking  Fund, 

To— Cash, 

To  record  annual  instalment  as  before. 

(11) 

xj      ,  T  ,                                 January  1,  1920 
oond  Interest,  " 

To— Bond  Sinking  Fund, 

To  record  annual  interest  payment 
on  bonds  now  outstanding.  Had 
maturity  date  been  given,  the  next 
entry  would  cover  amortization  in- 
stalment. 

(12) 

-              ,  ^                               January,  1920 
5  per  cent  Bonds  Payable,        ~  

To— Unamortized  Bond  Discount, 
Bond  Sinking  Fund, 
To  record  purchase  of  11   bonds  of 
$1,000.00  each  from  sinking  fund  at  98. 
At  this  moment,  $10,800.00  remains 
in  the  fund: 
Debits: 

Dec.  31,  1918, 
Dec.  31,  1919, 

Total, 
Credits: 

Dec.  31,  1918, 

Interest,         $25,000 
Jan.  (_,)  1919, 

Purchase,  9,700 

Dec.  31,  1919, 
Interest,  24,500    $59,200 

Balance, 


$1,000.00 


$1,000.00 


$35,000 
$35,000 

$70,000 


Purchase,  this  entry, 
Balance, 


10,800 
10,780 

20 


$35,000  00 


$35,000  00 


$24,500.00 


$24,500.00 


$11,000  00 


$220.00 
$10,780.00 


278 


ADVANCED  ACCOUNTING 


$1,100.00 


11,100.00 


$479,000  00 

$47»,000.00     $479,000  00 


Bond  Interest,  ^^^^ 

To — Unamortized  Bond  Discount, 

To  reduce  amount  of  discount  for  same 

reasons  as  shown  in  entry  (9)  above, 

applicable  to  the  $11,000.00  of  bonds 

retired. 
At  this  point,  a  Trial  Balance  is  to  be  prepared;  it  follows: 
Cash,  $380,000.00 

Bond  Sinking  Fund,  20 .  00 

Unamortized  Bond  Discount,  47 ,  380 .  00 

Bond  Interest,  fi  i ,  600 .  00 

6  per  cent  Bonds  Payable, 

Totals, 

Problem  2.— This  problem  perhaps  is  a  little  more  difficult  than  the  first 
one  above  in  that  more  entries  are  required.  Likewise,  as  before,  thc^  lack 
of  certain  information  prevents  the  proper  amortization  of  the  bond  discount 
and  expense;  this  being  the  case,  the  expedient  has  been  used  of  charging 
oflf  this  item  at  once,  rather  than  holding  the  amount  in  abeyance  until  the 
solution  is  completed, — but  indicating  just  where  the  periodic  reductiong 
should  occur.     By  so  domg,  a  variation  in  solution  is  secured. 

The  Standard  Trust  Company  is  appointed  by  the  Peninsular  Mining 
Company  as  trustee  of  a  bond  issue,  aggregating  $1,000,000.00,  all  Bonds  oi 
$1,000.00  denomination,  rate  5  per  cent,  and  bearing  date  January  1,  1914. 
Bonds  mature  in  ten  equal  annual  instalments,  beginning  January  1,  1917, 
unless  previously  converted  or  retired. 

The  issue  is  not  purchased  by  the  trustee,  but  is  sold  through  Emory 
Davis  &  Company,  Brokers,  the  company  realizing  90  per  cent  and  accrued 
interest  less  the  cost  of  appraisal  of  property,  printing,  trustees'  expenses, 
etc.,  amounting  to  $9,310.80.  (Fees  not  included  above). 


Schedule  of 

InBtal. 

Due 

Discount 

Years  to 

No. 

Date 

Amount 

Involved 

Run 

12/31/14 

12/31/15 

12/31/16 

12,81/17 

1 

1/1/17 

$100,000.00 

$10.000  00 

3 

13,333.33 

$3,333.33 

$3,333  34 

2 

1/1/18 

100,000.00 

10.000.00 

4 

2.500.00 

2,500.00 

2.500.00 

12,600.00 

3 

1/1/19 

100,000.00 

10.000  00 

5 

2.000.00 

2.000.00 

2.000.00 

2.000.00 

4 

1/1/20 

100,000  00 

10.000.00 

6 

1,666.66 

1.666.66 

1.666.67 

1,666.67 

5 

1/1/21 

100,000  00 

10,000.00 

7 

1.428.57 

1.428.57 

1,428.57 

1.428.57 

6 

1/1/22 

100,000.00 

10.000.00 

8 

1.250.00 

1.250.00 

1.250.00 

1.250.00 

7 

1/1/23 

100.000.00 

10.000  00 

9 

1.111.11 

1.111.11 

1.111.11 

1,111.11 

8 

1/1/24 

100.000.00 

10.000  00 

10 

1.000  00 

1,000.00 

1.000  00 

1.000.00 

9 

1/1/25 

100,000  00 

10.000.00 

11 

909.09 

909.09 

909.09 

009.09 

10 

1/1/26 

100,000.00 

10.000.00 

12 

833.33 
$16,032  09 

833  33 
$16,032  09 

833.33 
$16,032  11 

833.33 

Totals. 

SI, 000, 000. 00 

SIOO.OOO  00 

$12,698  77 

The  above  schedule  has  been  prepared  on  what  may  be  called  the  "straight  line"  plan  as  against  the 
The  first  instalment,  $100,000.00.  matures  in  three  years;  therefore,  on  the  straight  line  plan,  1  ;i  of  the 
■0  that  such  account  will  show  the  true  expense  of  borrowed  capital.    In  other  WOTds,  on  December  81, 1914, 
However,  since  the  problem  does  not  indicate: 

1.  Which  of  the  bonds  were  converted  into  preferred  stock  at  90,  on  January  1,  1916.  and 

2.  Which  of  the  bonds  were  redeemed  at  103.  on  January  1,  1917, 

it  is  imposrible  to  adjust  the  discount  m  it  should  be  adjusted,  without  assuming  certain  thine*.    And 
indicate  that  the  student  und««tands  the  case  in  hand. 


CORPORATE  OBLIGATIONS;  BONDS  PAYABLE  279 

20^1914''**'^^  '^"^  "^^  ^^^^"^  ''''^'"'  *'''*  ^""'^  ^""'^  ^^  *^^  ^^""^^^  ^'^  January 
Among  other  things  the  trust  deed  provides: 

Bonds  convertible  on  any  interest  date  for  6  per  cent  preferred  stock 
at  90,  at  option  of  holder. 

Bonds  may  be  retired  out  of  sinking  fund  on  any  interest  date  at  103. 
at  option  of  company. 

Sinking  fund  for  payment  of  principal  only  to  be  based  on  annual  produc- 
tion of  ore  at  10  cents  per  ton. 
Trustee  to  charge  1/4  per  cent  of  principal  on  issue,  and  1/4  per  cent 

on  coupons.     Interest  payable  January  1  and  July  1. 
The  company's  production  for  three  years  is  assumed  to  be.  for  the 
purpose  of  this  problem,  1,000,000  tons  per  year 

January  1,  1916,  $100,000.00  are  converted  to  preferred  stock 
January  1,  1917,  $200,000.00  are  redeemed  at  103. 
Formulate  all  necessary  entries  for  the  books  of: 

a.  Standard  Trust  Company, 

b.  Peninsular  Mining  Company, 

c.  Emory  Davis  &  Company, 

^atar;^l^^l7"TcT.^^^^  ''^  ^'^^^  ^'^'^^^^^^^'^^  "p  ^  -^  -^^^^-« 

Solution  to  Problem  ^.-The  requirements  of  this  problem  contemplate 
entries  upon  three  distinct  sets  of  books: 

1.  The  issuing  company. 

2.  The  brokers. 

3.  The  trustee. 

Therefore,  this  solution  ha^  been  divided  into  three  distinct  parts. 
Part  1  of  solvJtwn.-This  portion  of  the  solution  relates  to  the  books  of 
the  Pemnsular  Mmmg  Company,  and  has  been  separated  into  two  sections: 

Amortization 


12/31/18   12/31/19  12/31/20  12/31/21  12/31/22  12/31/23  12/31/24  12/31/25 


Total 


12.000.00 
1,666.67  $1,666  67 
1.428.57  1.428.57  $1,428.58 

1.250  00  1.250.00  $1,250.00 


1.250.00 

1.111.11 

1.000.00 

909.09 

833.33 


1.111  11  1,111.11  1.111.11  $1,111.12 

1,000.00  1.000.00  1.000.00  1.000.00  $1,000  00 

090  09  909.09  909.09  909.09    909  09 

833.33  833.33  833.33  833.34.   833  34 


$909.10 
833.34 


$833.34 


$10,000  00 
10,000.00 
10.000.00 
10.000  00 
10,000  00 
10.000.00 
10,000.00 
10.000.00 
10.000.00 


-— — IZI ^         »»»..„.        ooo.ot  iJM.M     S833.34         10.000  00 

.$10.198.77   $8.198.77   $6.532.11    $5.10353   $3.853  55   $2.742  43   $1,742.44    $833 . 34 1I^^:^i;;(rr;;i 
'eflfective  rate"  plaa  ^^^=============== 

^iZl^wT""!  T^T  "'"*"'  "^  """^^-  '^  ^•^  «»*^  ^'''^  *»»«  B-d  Interest  «xKnmt 
$16,032.09  must  be  charged  to  Bond  Interest  account  and  be  credited  to  Bond  Discount  account. 


theoretical  assumptions  better  not  be  made  unless  absolutely  neces.^  in  securing  a  solution  which  wiU 


h 


'i 


\r 


1^ 


280 


ADVANCED  ACCOUNTING 


1.  Schedule    of    amortization    covering    bond    discount.     The    specific 
information  lacking  m  this  problem  relates  to  the  following- 

a.  What  bonds  were  converted  to  preferred  stock  on  January  1,  1916T 

b.  What  bonds  were  redeemed  on  January  I    1917? 

n^^TZ""'  "T.,!''?"f  ft  ™""'*  P*"*^'"  '"*^»^ti"8  «°t"«s  cannot  b« 
made,  because  of  the  lack  of  the  above  information,  it  is  possible  nevertheles. 

u'^^^i^  u  amortisation  schedule  covering  the  discount  on  the  bonds 
sold  This  has  been  done  even  though  the  problem  does  not  definitely  call 
for  the  same.     (See  schedule  on  pp.  278  and  279) 

2.  Entries  upon  the  books  of  the  Peninsular "  Mining  Company.     For 
indiclter   ''"''^''  '^"'"''"   adjustment   and   closing   entries   are 

January  1,  1914 
Unissued  Bond8-5  per  cent,  ~^i ,  ooo .  000 .  00 

lo— Bonds  Payable — 5  per  cent, 

To  record  authorized  bond  issue. 
Standard  Trust  Company,  $1 ,  000 .  000  00 

To — Unissued  Bonds— 5  per  cent, 

To  record  transfer  of  entire  issue 
to  trustee. 

January  20,  1914 


$1,000,000.00 


$1,000,000.00 


Cash, 
Bond  Discount, 
Bond  Expenses, 

Sinking  Fund  Expense  (Trustee  Fees), 
To — Standard  Trust  Company, 
Bond  Interest  (Accrued), 

To  record  sale  proceeds;  sale  at 
90,  plus  accrued  interest,  less 
expenses  and  trustee  fees: 
Bond  discount: 
$1,000,000.00  less  $900,000.00 

$100,00000 

Gross  cash  received,$900 ,  000 .  00 
Bond  expense, 

$9,310.80 
Trustee  fees: 
1/4  per  cent  on 
total, 

$2,500.00     $  11,810.80 


$890,966.98 

100,000.00 

9,310.80 

2,600.00 


$1,000,000.00 
2,777.78 


Interest  accrued: 
20  days  at  5  per 
cent,    (using    4 
places). 


$888,189.20 


$    2,777.78 


Balance,  cash,     $890,966.98 


CORPORATE  OBLIGATIONS;  BONDS  PAYABLE 


281 


July  1,  1914 
Bond  Interest,  j^.  ^^  ^ 

^'t^S  ^''""  ^^"^'  '^"^^'  62  50 

To  record  payment  to  trustee  of 
half-year  interest  plus  1/4  per  cent 
commission  or  fee  on  coupons. 

December  31,  1914 
Bond  Interest,  " 


$25,062.50 


Siting  Fund  Expense  (Trustee  Fees), 
To— Liabilities  Accrued, 

p    «.      7?  ^^*  "P  ^^^"""^^  P"or  to  closing. 
Profit  and  Loss  (Sinking  Fund  Income), 
lo — Bond  Discount, 
Bond  Expenses, 
Sinking  Fund  Expense, 
Bond  Interest, 
To  close.     The  lack  of  proper 
information  prevents  amortiza- 
tion of  the  discount  and  expense 
of  the  bond  issue  from  being 
taken  care  of  as  it  should  be. 
The  same  was  true  in  Problem 
No.  1,  above,  and  therein  the 
unamortized  amount  was  car- 
ried along  to  be  set  out  in  the 
final    Trial    Balance;    in    the 
present  instance,   to   iUustrate 
the  periodical  adjustment  and 
closing  of  a  set  of  books,  the 
entire  amount  has  been  written 
off  at  once,     l^he  point  to  re- 
member is,  that,  in  any  given 
actual  case,  neither  procedure  is 
satisfactory    nor    correct,    the 
amortization  principle  being  the 
only  correct  one  to  follow. 

January  1,  1915 
Standard  Trust  Company  (Sinki^^lw 

Trustee), 
Liabilities  Accrued, 
To— Cash, 

To  record  payment  to  trustee  of 
annual  instalment  to  sinking 
fund  for  bond  redemption,  plus 
interest  at  5  per  cent  on  bonds 
outstanding  and  commission  or 


$25,000.00 
62.50 


$159,158.02 


$25,062.50 


$100,000.00 

9,310.80 

2,625.00 

47,222  22 


$100,000.00 
25,062.50 


$125,062.50 


282 


ADVANCED  ACCOUNTING 


fees  for  interest  on  coupons  ac- 
crued as  under  12/31/14. 
Profit  and  Loss  (Surplus), 

To — Reserve  for  Sinking  Fund, 

The  trust  deed  apparently 
states  nothing  to  the  effect  that 
the  sinking  fund  must  be  set 
aside  out  of  profits,  but  above 
entry  made  on  assumption  that 
this  is  desired,  since  it  is  usual  so 
to  do.  The  same  entry,  then, 
should  be  made,  also,  under 
dates  of  January  1,  1916,  and 
January  1,  1917. 

July  1,  1915 
Bond  Interest, 

Sinking  Fund  Expense  (Trustee  Fees), 
To— Cash, 

See  entry  of  July  1,  1914,  above. 

December  31,  1915 
Bond  Interest, 


$100,000.00 


$100,000.00 


$25,000.00 
62.50 


$25,062  50 


Sinking  Fund  Expense  (Trustee  Fees), 
To — ^Liabilities  Accrued, 

See  entry  of  12/31/14,  above. 
Profit  and  Loss  (Sinking  Fund  Income), 
To — Bond  Interest, 

Sinking  Fund  Expense   (Trustee 
Fees), 
See  entry  of  12/31/14,  above. 

January  1,  1916 

Standard  Trust  Company  (Sinking  Fund 

Trustee) , 
Liabilities  Accrued, 
To— Cash, 

See  entry  of  1/1/15,  above. 
Profit  and  Loss  (Surplus), 

To — Reserve  for  Sinking  Fund, 

See  entry  of  1/1/15,  above. 
Bonds  Payable — 5  per  cent, 

To— Unissued     Capital     Stock— Pre- 
ferred— 6  per  cent. 
Profit  on  Bond  Conversion, 
To  record  conversion  of  $100,- 
000.00  of  outstanding  bonds  at  90, 
into  preferred  stock — 6  per  cent. 
The    credit    to    the    Unissued 


$25,000.00 
62.50 


$50,125.00 


$25,062  50 

$50,000  00 
125  00 


$100,000.00 
25,062.50 


$100,000.00 


$100,000.00 


$125,062  50 


$100,000  00 


$90,000.00 
$10,000  00 


CORPORATE  OBLIGATIONS;  BONDS  PAYABLE  283 


Capital  Stock — Preferred  ac- 
count assumes  that  the  author- 
ized issue  thereof  has  been 
spread  upon  the  records.  Like- 
wise, if  bond  discount  were 
amortized  properly,  the  credit 
of  $10,000.00,  as  above,  in  part, 
proportionately,  necessarily 
would  be  against  the  account 
of  Discount  on  Bonds;  but  in 
view  of  the  treatment  followed 
in  this  solution,  the  above  credit 
would  be  in  order. 

July  1,  1916 
Bond  Interest, 

Sinking  Fund  Expense  (Trustee  Fees), 
To— Cash, 

See  entry  of  7/1/14.  In  this 
case,  there  are  $100,000.00  less 
bonds  outstanding  than  pre- 
viously. Therefore,  the  interest 
and  fee  charge  must  be  less 
than  before. 

December  31,  1916 
Bond  Interest, 

Sinking  Fund  Expense  (Trustee  Fees), 
To — ^LiabiUties  Accrued, 

See  entry  of  12/31/14,  adjusted 
to    meet    reduced    amount    of 
bonds  outstanding. 
Profit  on  Bond  Conversion, 
Profit  and  Loss  (Sinking  Fund  Income), 
To — Bond  Interest, 

Sinking  Fund  Expense  (Trustee 
Fees), 
See  entry  of  12/31/14. 

January  1,  1917 
Standard  Trust  Company  (Sinking  Fund 

Trustee), 
Liabilities  Accrued, 
To— Cash, 

See  entry  of  1/1/15,  above. 
Profit  and  Loas  (Surplus), 
To — Reserve  for  Sinking  Fund, 

See  entry  of  1/1/15,  above. 
Bonds  Payable — 5  per  cent. 
Sinking  Fund  Loss  (Premium  on  Bonds 
Retired), 


$22,500.00 
56.25 


$22,556.25 


$22,500.00 
56.25 


$22,556.25 


$10,000.00 
35,112.50 


$45,000.00 
112.50 


$100,000.00 
22,556.25 


$100,000.00 


I 


$122,556.25 


$100,000  00 


$200,000.00 
6,000.00 


ii 


284 


ADVANCED  ACCOUNTING 


$206,000.00 


To — Standard  Trust  Company  (Sink- 
ing Fund  Trustee), 

To  record  redemption  of  $200,- 
000.00  of  bonds  from  the  sink- 
ing fund  at  103. 

The  above  completes  the  entries  necessary  on  the  books  of  the  Peninsular 
Mining  Company.  As  indicated  already,  in  an  actual  case,  the  entries 
shown  will  differ  due  to  the  fact  that  periodically,  upon  each  interest 
paying  date,  there  should  be  charged  to  the  interest  account  a  certain 
amount  of  the  discount  upon  the  original  issue. 

Part  2,  of  solution. — The  entries  upon  the  books  of  the  brokers,  Emory 
Davis  &  Company,  are  as  follows: 


January  20,  1914 


$902,777.78 


$902,777.78 


Peninsular  Mining  Company — 5  per  cent 

Bonds, 
To— Cash, 

To  record  purchase  of  $1,000,- 
000.00,  par  value,  of  above 
bonds  at  90,  plus  accrued  in- 
terest. The  information  pre- 
sented in  the  problem  does  not 
indicate  that  any  other  transac- 
tions occured  subsequent  to 
purchase  and  sale. 

Part  S,  of  solution.— The  entries  upon  the  books  of  the  trustee,  the 
Standard  Trust  Company,  are  given  below.  A  question  may  arise  as  to 
the  propriety  of  the  adjusting  entry  on  each  December  31,  covering  the 
accrual  of  commission  in  that  thecommission  is  said  to  bepayable  on  coupons 
redeemed  on  January  1,  subsequently.  However,  the  interest  is  due  from 
the  Peninsular  Mining  Company  on  December  31,  and  the  commiflmon 
thereon  should  be  attached  thereto.  If  both  items  are  accrued  as  of  this 
date  for  closing  purposes,  the  commission  must  be  booked  as  a  liability. 
Being  booked  as  a  liability,  its  amount  is  an  asset  to  some  one  else,  the 
trustee;  hence,  if  the  latter's  books  be  kept  upon  an  accrual  basis,  it  seems 
that  the  asset  may  be  taken  up  thereon. 

January  1,  1914 

Peninsular  Mining  Company — 5  per  cent 
Bonds, 

To — Peninsular  Mining  Company, 

To   record   issue   of   bonds   of 

above    company    received    as 

trustee. 

January  20,  1914 

Cash,  $902,777.78 

Peninsular    Mining   Company 

(for   discount),  100,000.00 


$1,000,000.00 


$1,000,000.00 


CORPORATE  OBLIGATIONS;  BONDS  PAYABLE 


285 


To— Peninsular    Mining    Company — 
5  per  cent  Bonds, 
Peninsular  Mining  Company  (for 
accrued  int.), 

To  record  sale  of  entire  above 
bond  issue  to  Emory  Davis  & 
Company,  brokers,  at  90,  plus 
accrued  interest. 
Peninsular  Mining  Company, 
To— Cash  (or  Vouchers  Payable), 

To  record  expenses  of  bond  issue. 
Peninsular  Mining  Company, 
To — Commission  (Fees), 
Cash, 

To  record  payment  to  above 
company  of  net  proceeds  of 
bond  issue,  less  commission  of 
1/4  per  cent. 

July  1,  1914 
Cash, 

To — Commission  (fees), 

Peninsular    Mining    Company — 
(Bond  Interest), 
To  record  receipt  from  above 
company  of  cash  to  pay  semi- 
annual   interest    charges,    plus 
1/4  per  cent  fee. 
Peninsular     Mining     Company— (Bond 
Interest), 
To— Cash, 

To  record  payment  of  interest 
coupons  on  bond  issue  of  above 
company. 

December  31,  1914 

Accrued  Assets,  ~ 

To — Commission  (fees). 


$1,000,000.00 

2,777.78 


$9,310.80 


$893,466.98 


$9,310.80 


$2,500  00 
890,966.98 


$25,062  50 


$62  50 
25,000  00 


$25,000.00 


$25,000  00 


$62.50 


$2,625.00 


To  adjust  books,  prior  to  clos- 
ing, of  accrued  asset. 
Commission  (fees), 
To — Profit  and  Loss, 
To  close. 

January  1,  1915 

To — Accrued  Assets, 

Peninsular   Mining  Company 
(Bond  S.  Fund), 


$62  50 


$2,625.00 


$62  50 

$100,000  00 


I 


286 


ADVANCED  ACCOUNTING 


Peninsular   Mining   Company 
(Bond  Interest), 
To  record  receipt  of  cash  for 
purposes  shown  above. 
Peninsular     Mining     Company     (Bond 
Interest), 
To— Cash, 

See  entry  of  7/1/14. 

July  1,  1915 


25,000.00 


$25,000  00 


$25,000  00 


Caflh, 

$25,062.50 

To — Commission  (fees). 

$62  50 

Peninsular  Mining  Company  (Bond 

Interest), 

25,000  00 

i                                              See  entry  of  7/1/14. 

Peninsular  Mining  Company  (Bond  Interest), 

$25,000.00 

\                                  To— Ca«h, 

$25,000  00 

j                                                 See  entry  of  7/1/14. 

December  31,  1915 

Accrued  Assets, 

162.50 

L                                   To — Commission  (fees), 

$63  60 

P                                                 See  entry  of  12/31/14. 

Commission  (feesj, 

$125.00 

To — Profit  and  Loss, 

$125.00 

See  entry  of  12/31/14. 

>                                                                                    January  1,  1916 

P                                Cash, 

1                                    To — Accrued  Assets, 

$125,062.50 

$62  50 

Peninsular  Mining  Company  (Bond  S. 

Fund), 

100,000  00 

Peninsular   Mining   Company    (Bond 

Interest), 

25,000.00 

See  entry  of  1/1/15. 

Peninsular  Mining  Company  (Bond  Interest), 

$25,000.00 

To— Cash, 

25,000.00 

See  entry  of  7/1/14. 

1                                                                                   July  1,  1916 

Cash, 
To — Commission  (fees), 

Peninsular   Mining   Company    (Bond 
Interest), 

See  entry  of  7/1/14.  Note  that  on 
January  1, 1916,  $100,000.00of  bonds 
were  retired;  hence,  the  reduction  in 
interest  and  commission  charges. 
Peninsular  Mining  Company  (Bond  Interest), 
To— Cash, 

See  entry  of  7/1/14. 


$22,556.25 


$22,500.00 


$56  25 
22,500  00 


$22,500  00 


CORPORATE  OBLIGATIONS;  BONDS  PAYABLE 


287 


December  31,  1916 
Accrued  Assets,  |5g  25 

To — Commission  (fees). 

See  entry  of  12/31/14. 
Commission  (fees),  $112.50 

To — Profit  and  Loss, 

See  entry  of  12/31/14. 


$56.25 


$112.50 


$122,556.25 


$22,500.00 


$56.25 

100,000.00 

22,500.00 


$22,500.00 


$206,000  00 


January  1,  1917 
Cash, 
To — Accrued  Assets, 

Peninsular  Mining  Company  (Bond  S. 

Fund), 
Peninsular   Mining  Company   (Bond 
Interest), 
See  entry  of  1/1/15. 
Peninsular  Mining  Company  (Bond  Interest), 
To— Cash, 

See  entry  of  7/1/14. 
Peninsular  Mining  Company  (Bond  S.  Fund),     $206,000  00 
To— Cash, 

To  record  purchase  and  redemption 
of  $200,000.00  of  bonds  of  above 
company  at  103. 

Annuities  and  Sinking  Funds.— A  sinking  fund  may  be 
accumulated  in  numerous  ways,  the  commonest  and  simplest 
being: 

1.  Equal  periodical  amounts  set  aside,  without  regard  to  in- 
terest earnings  thereon.  If  interest  be  earned  upon  the 
amounts  regularly  set  aside,  such  interest  is  sent  into  gen- 
eral income,  not  into  sinking  fund  income. 

2.  Equal  periodical  amounts  are  set  aside,  as  annually,  which, 
at  compound  interest;  will  accumulate  to  the  sum  desired 
at  the  end  of  a  certain  number  of  years  to  meet  the  prin- 
cipal of  the  obligation  then  due. 

The  second  method  of  creating  a  sinking  fund  relates  to  an 
annuity,  the  annual  installment  so  required  being  thus  defined 
Likewise,  since  certain  difficulties  may  arise  in  the  calculation 
of  its  amount,  it  seems  expedient  to  present  certain  principles 
related  thereto  which  an  accountant  ought  to  comprehend. 

In  determining  the  amount  of  a  sinking  fund  instalment,  one 

works  with  the  mathematical  process  known  as  annuities.'    In 

fact,  in  the  present  worth  calculation  given  in  a  preceding  chap- 

^  ter  in  connection  with  bond  investments  the  annuity  principle 


288 


ADVANCED  ACCOUNTING 


was  used,  which  in  that  connection  might  be  restated,  from  the 
present  viewpoint,  about  as  follows:  An  investor  wishes  to  pur- 
chase an  annuity  which  will  return  him  an  income  of  $ , 

^or years.     In  the  present  instance,  in  determining  the 

amount  of  a  sinking  fund  instalment,  two  variations  only  will 
be  presented,  in  that  this  volume  is  not  presumed  to  be  a  treatise 
on  mathematics: 

1.  The  amount  of  a  sinking  fund  instalment  where  interest 
on  the  debt  is  not  considered. 

2.  The  amount  of  a  sinking  fund  instalment  where  interest 
on  the  debt  is  to  be  considered. 

Both  of  the  above  will  be  discussed  from  the  point  of  view  of 
payments  being  made  at  the  end  of  each  year,  not  at  the  begin- 
ning thereof. 

Calculating  an  annuity,  which  latter  may  be  defined  as  the 
payment  of  a  definite  sum  of  money  at  regular  recurring  inter- 
vals, or  as  a  series  of  payments  of  equal  amounts  due  at  regular 
intervals,  is  based  upon  the  use  of  compound  interest;  hereunder, 
interest  is  earned  on  both  the  principal  invested  and  on  the 
interest  accruing  from  period  to  period  which,  in  turn,  is  invested 
also.  The  amount  thus  to  be  set  aside  periodically  may  be 
determined  in  any  one  of  the  following  ways: 

1.  By  an  arithmetical  procedure  involving  calculations  more 
or  less  cumbersome. 

2.  By  the  use  of  annuity  tables. 

3.  By  the  use  of  algebraic  formulas. 

The  method  followed  herein  is  an  arithmetical  procedure 
which,  although  cumbersome,  is  more  readily  comprehended  by 
the  average  student  than  that  which  savors  of  algebra. 

If  $1.00  is  invested  at  4  per  cent  for  twenty  years,  compounded 
annually,  the  $1.00  will  amount  to  $2.19112314,  at  the  end  of 
such  time.  This  means  that  there  is  a  regular  annual  addition  of 
4  cents  to  the  original  $1.00,— which,  in  turn,  increases  at  4  per 
cent  annually.  If  the  original  $1.00  is  placed  in  one  bank  account 
for  the  full  period  of  twenty  years,  and  the  annual  interest  is 
taken  thence  when  due  and  is  placed  in  another  bank  account,  in 
which  account  it  will  earn  the  same  rate  of  interest  as  before,  at 
the  end  of  twenty  years  there  will  be: 

1.  In  bank  account  No.  1,  $1.00 

2.  In  bank  account  No.  2,  $1 .  19112314 


CORPORATE  OBLIGATIONS;  BONDS  PAYABLE  289 

The  latter  amount  represents  an  annuity  of  4  cents  per  annum 
paid  into  bank  account  No.  2,  for  twenty  years.  Hence  it  may  be 
said  that  this  $1.19112314  is  the  value  at  maturity,— the  ulti- 
mate or  final  value  of  an  annuity  of  4  cents  for  twenty  years  at 
4  per  cent.  Further,  herefrom,  the  final  value  of  an  annuity  of 
$1.00  may  be  determined  quickly,  as  under: 

1^9112314X100^29.7780785 

And,  in  turn,  from  the  above,  the  final  value  of  an  annuity 
of  any  amount,  under  the  conditions  assumed,  may  be  calculated 
Assume,  for  example,  $2,000,000.00  as  a  basis  of  calculation- 
$2,000,000.00  divided  by  29.7780785  equals  $67,163.50,  repre- 
senting the  annual  amount  desired. 

Problem.— The  foUowing  problem  has  been  framed  to  illustrate  further 
the  prmciples  presented  above.  It  is  a  C.  P.  A.  problem  revamped  A 
contractor  proposes  to  build  a  bridge  for  a  certain  city  and  accept  the  city's 
4  per  cent  twenty-year  bonds  in  the  amount  of  $2,000,000.00  in  payment 
What  amount  must  be  set  aside  at  the  end  of  each  year,  compounded  at 
4  per  cent,  to  meet  the  obligation  when  due? 

The  solution  of  this  problem  has  been  given  above,  the  annual  addition 
to  the  smking  fund  being  $67,163.50.  If  a  rule  were  to  be  propounded  upon 
the  basis  of  the  above  deductions,  it  might  read  as  foUows: 

1.  Find  the  final  value  of  an  annuity  of  $1.00,  for  the  given  time  and  the 
given  rate,  by: 

a.  Determining  the  compound  interest  on  $1.00  for  the  given  period 
at  the  given  rate,  and 

b.  Multiply  by  100  and  divide  by  the  given  rate. 

2.  Divide  the  amount  of  the  obUgation  by  the  result  secured  in  (1)- 
the  annual  sinking  fund  addition  wiU  equal  the  final  amount  secured' 

The  above  calculations  were  made  without  the  use  of  interest  tables- 
If  these  latter  are  available,  the  work  would  be  reduced  materially 

The  above  illustration  covers  the  first  possibility  to  be  discussed,  determin- 
ing the  annual  contribution  to  a  sinking  fund  without  reference  to  interest 
upon  the  obhgation  in  question.  Suppose  now,  that  this  same  city  borrowed 
the  $2,000,000,  to  carry  out  certain  improvements,  and  the  amount  is  to  be 
repaid  by  equal  annual  instalments  including  both  principal  and  interest 
the  mterest  rate  being  4  per  cent,  and  the  time  twenty  years. 

Hereunder,  the  requirement  may  be  stated  in  either  of  the  two  foUow- 
mg  ways: 

1.  What  equal  annual  payment  is  equivalent  to  $2,000,000.00,  invested 
at  4  per  cent,  or 

2.  What  annuity  can  be  purchased  for  $2,000,000.00,  money  being  worth 
4  per  cent  per  annum? 

Solulion.-tl.W=%2.19imU,  the  amount  of  $1.00,  in  twenty-years  at 


I 


\! 


290 


ADVANCED  ACCOUNTING 


^ 


1,932,836  50 
77,313  46 
69,850  04 


4  per  cent  $2. 191 12314  X  $2,000,000=  $4,382,246.28,  the  amount  of  $2,000,- 
000.00  in  twenty  years  at  4  per  cent. 

— ^ ^ =  $29.7780785,  the  final  value  of  $1.00,  annual  payment 

for  twenty  years  (see  above). 

29  7780785    ^  $147,163.50,  the  amount  of  the  equal  annual  payment  re- 
quired (answer). 

Total  amount  of  bonds,  $2 ,  000 ,  000 .  00 

Interest  at  end  of  first  year,  go  000  00 

Annual  payment,  147 ,  163 .  50 

Hence,  $147,163.50  less  $80,000.00  equals,  67, 163  50 

the  amount  of  the  first  redemption  of  debt. 
$2,000,000.00  less  $67,163.50  equals, 

the  amount  of  debt  drawing  interest  in  the  second  year. 
$1,932,836.50  X  .04  equals, 

interest  due  at  the  end  of  second  year. 
$147,163.50  less  $77,313.46  equals, 

amount  of  second  redemption  of  debt. 

The  process  may  be  continued  from  year  to  year.  In  each  succeeding 
year,  as  the  interest  payment  is  reduced,  the  payment  against  the  principal 
is  increased. 

The  rule  deduced  from  the  second  example  above  might  be  stated  as 
follows: 

1.  Determine  the  compound  amount  of  the  given  sum  for  the  given  time 
at  the  given  rate. 

2.  Divide  by  the  final  value  of  an  annuity  of  $1.00  for  the  same  time  and 
at  the  same  rate. 

The  third  and  last  possibility  to  be  considered  relates  to  determining 
the  period  of  an  annuity, — or  determining  the  number  of  years  that  will 
be  required  to  redeem  a  debt,  the  amount  of  the  debt  being  known,  as  well 
a*  the  periodical  amount  that  can  be  counted  upon  to  be  set  aside  for 
redemption  purposes.  Assume  a  corporation  desires  to  borrow  $25,000.00, 
to  develop  a  new  line.  Its  oflacers  determine  that  they  can  count  upon 
$2,000.00  a  year  to  repay  the  obligation.  How  many  years  must  the  debt 
run,  on  the  basis  of  these  assumptions,  money  being  worth  5  per  cent? 

$2,000.00,  annually  paid  over  will  liquidate  the  obligation  of  $25,000.00, 
with  5  per  cent  interest  thereon,  in  an  unknown  length  of  time,  or  number  or 
years.  Restated,  there  exists  an  annuity  of  $2,000.00,  for  an  unknown 
period  of  years,  at  5  per  cent.  Further,  an  annuity  of  $1.00,  will  have  a 
present  worth  for  this  same  unknown  period,  at  the  same  rate,  in  the 

.     .  $25,000.00       ^,^  ,^ 
^"^^^^  ^^    2,^.00     =  *12.50. 

Consulting  the  annuity  tables,  one  seejts  for  the  amount  nearest  to  $12.60, 
that  is  therein  contained,  on  the  basis  of  5  per  cent.  This  is  found  to  be 
$12.46221,  which,  upon  scrutiny,  is  noticed  as  being  the  present  worth  of 
$1.00  for  twenty  years.  Hence,  in  round  numbers,  this  $25,000.00  obligation 
may  be  repaid  in  twenty  +  years. 


CORPORATE  OBLIGATIONS;  BONDS  PAYABLE  291 

Cancellation  of  Redeemed  Bonds  and  Paid   Coupons.— 

When  an  outstanding  bond  issue  has  been  fully  paid  up,  and  all 
the  interest  accumulated  there  against  has  been  washed  clean, 
it  IS  necessary  to  have  the  trust  deed  or  mortgage  discharged  as 
of  record.  However,  unless  the  corporation  has  followed  out 
certain  procedures  during  the  period  of  the  obligation's  existence 
to  the  end  that  the  trustee,  legally,  may  become  a  party  to  the 
mortgage  release  without  incurring  personal  liability  because  of 
the  wrongful  discharge  of  his  duties,  the  satisfaction  cannot  be 
obtained. 

As  bonds  are  paid,  they  should  be  cancelled  and  be  kept 
carefully  to  be  presented  later  for  the  personal  scrutiny  of  the 
trustee.  Similar  treatment,  likewise,  should  be  accorded  the 
bond  coupons  as  they  are  paid  from  time  to  time.  Before  the 
trust  deed  or  mortgage  finally  is  discharged,  the  trustee  will 
require  that  all  coupons  be  presented  to  him  for  his  personal 
examination.  Since  some  coupons  will  have  been  lost  or  de- 
stroyed accidentally  by  the  bondholders,  and  some,  perhaps,  will 
not  have  been  presented  for  payment,  some  coupons  always  will 
be  missing.  The  open  spaces  in  the  coupon  books  will  show  what 
coupons  are  missing  and  outstanding. 

If  the  trustee  finds  certain  coupons  missing,  he  will  require  a 
bond  to  be  given  to  protect  himself  against  a  possible  later 
presentation  for  payment;  this  bond  will  be  double  the  amount 
of  the  missing  coupons. 

If  a  bond  issue  be  of  considerable  size  and  the  final  date  of 
payment  is  far  in  the  future,  considerable  difficulty  may  be 
experienced  in  caring  for  the  cancelled  coupons  during  the  inter- 
vening period  of  time.  The  coupon  books  quickly  become 
voluminous  in  size,  and  fireproof  storage  facilities  needed  in 
caring  for  them  may  require  the  incurment  of  considerable 
expense.  Because  of  this,  it  is  a  frequent  practice  to  destroy 
the  accumulated  cancelled  coupons  from  time  to  time.  To  effect 
this  destruction  properly,  representatives  of  both  the  trustee  and 
the  corporation  will  inspect  the  cancelled  coupons,  after  which 
the  latter  will  be  burned  in  their  presence.  Subsequently,  these 
representatives  will  prepare  what  is  known  as  a  cremation  cer- 
tificate, covering  their  act,  and  this  the  trustee  will  accept  as 
evidence  th^t  the  coupons  indicated  thereon  have  been  cancelled 
and  destroyed  in  due  form. 


:i 


m 


i 


"tl 


CHAPTER  IX 

BALANCE  SHEET:  PROFIT  AND  LOSS  STATEMENT 

Introduction. — The  science  of  accounting  resolves  itself  into 
three  general  branches  or  divisions: 

1.  Recordative  accounting,  or  bookkeeping.  In  turn,  this  di- 
vision may  be  separated  into  three  constituent  elements: 

a.  Classification.  This  has  to  do  with  selecting  the  proper 
titles  for  Ledger  accounts  and  their  functions.  In  short, 
it  deals  with  resolving  the  pecuniary  effects  of  business 
transactions  into  their  proper  debits  and^  credits. 

b.  Bookkeeping  technique.  This  recordative  element  deals 
with  the  art  of  recording  in  proper  form  the  classified 
effects  of  business  transactions  in  terms  of  money.  It 
represents  the  manual  side  of  bookkeeping, — ^writing  up 
the  accounting  records  in  accord  with  the  rules  of  modern 
practice.  The  scope  of  this  element  commences  with  the 
opening,  and  ends  with  the  closing,  of  a  set  of  books 
(exclusive  of  the  compilation  of  financial  statements). 

c.  Form  and  arrangement  of  financial  statements.  This  ele- 
ment is  of  sufficient  importance  and  distinctiveness  to 
be  accorded  a  separate  treatment. 

2.  Constructive  accounting,  or  the  building  of  systems.  De- 
termining the  fundamental  operating  classification  of  ac- 
counts would  fall  under  this  heading,  whereas,  under 
recordative  accounting  the  classification  element  is  con- 
cerned with  selecting  the  proper  accounts,  from  the  pre- 
scribed classification,  in  which  a  particular  transaction  is  to 
be  recorded. 

3.  Inspective  accounting,  or  auditing. 

In  the  students*  earlier  accounting  work,  much  time  was  de- 
voted, or  should  have  been,  to  the  preparation  of  financial 
statements, — ^the  Balance  Sheet  and  the  Profit  and  Loss  State- 
ment.    The  importance  which  may  be  attached  to  statement 

292 


tl 


BALANCE  SHEET:  PROFIT  AND  LOSS  STATEMENT      293 

preparation  never  can  be  overemphasized  once  the  rudimentary 
basic  elementary  principles  have  been  mastered.  Only  by  means 
of  properly  prepared  statements: 

1.  Can  men  at  the  head  of  large  organizations  ever  hope  to 
keep  in  touch  intelligently  with  what  actually  has  been, 
and  is,  going  on  therein. 

2.  Is  it  possible  to  present  vital  facts  in  a  clear  and  effective 
manner  concerning  a  business  enterprise  to: 

a.  Those  in  control,  or 

b.  Those  interested,  as 

i.  Stockholders, 
ii.  Investors, 
iii.  Creditors. 
However  good  an  accountant  may   consider  himself,  if  his 
completed  statements  be  poorly  drawn,  the  following  results: 

1.  His  reputation,  should  he  have  one,  is  placed  in  jeopardy 
among  men  who  have  the  ability  to  discriminate  in  matters 
of  accounting. 

2.  An  avenue  is  opened  for  considerable  misunderstanding  as 
to  just  what  are  the  actual  conditions. 

An  apparently  harmless  statement,  poorly  constructed,  may 
become  a  dangerous  document  in  the  hands  of  those  who  use  it. 

The  present  chapter  was  written  because  of  the  importance 
attached  by  the  writer  to  this  phase  of  accounting.  Some  of  the 
more  approved  methods  of  preparing  financial  statements,  with 
which  the  writer  has  come  into  contact  in  practice,--as  to  con- 
tent, form,  arrangement,  and  terminology,— are  presented  for  the 
so-called  semi-mature  student. 

Of  necessity,  since  the  science  of  accounting  is  not  exact,  many 
items  are  treated  differently  by  different  accountants.  However, 
in  the  present  instance  the  writer  trusts  that  he  has  avoided 
theoretical  hair-splitting  distinctions.  In  presenting  elementary 
principles,  the  instructor  may  violate  law  or  practice  in  any  way 
he  deems  desirable  if  his  final  result  will  justify  such  procedure; 
for  example:  A  business  may  be  personified,  capital  may  be  con- 
sidered an  accountability  rather  than  a  liability,  etc.  But  the 
opinion  is  ventured  that  most  hair-splitting  distinctions  have 
little,  if  any,  use  in  training  the  more  advanced  student  to  the 
point  where  he  can,  with  intelligence,  perform  the  duties  required 


294 


ADVANCED  ACCOUNTING 


.1 


of  him  in  an  office  of  either  the  practitioner  of  merit  or  the 
discriminating  business  man. 

Preliminary  Suggestions.— Before  passing  to  the  major  dis- 
cussion of  the  present  chapter,  certain  suggestions  of  a  general 
nature  relating  to  statements  seem  in  order.  These  are  presented 
below  in  outline  form: 

1.  Highly  technical  terms  and  forms  should  be  avoided  where 
possible.  Every  statement  should  be  prepared  so  as  to  be 
intelligible  to  the  average  person  who  may  read  it.  Clear- 
ness of  expression  should  be  fundamental: 

a.  Terms  used  should  be  understandable  and  descriptive; 
abbreviations  should  be  avoided. 

b.  Figures  mean  practically  nothing  unless  explained. 

c.  If  in  a  major  statement  the  detailed  explanation  of  cer- 
tain items  will  take  up  too  much  space  and  tend  to 
confuse  the  reader,  a  summary  explanation  will  be  in 
order  thereon,  with  a  more  detailed  explanation  being 
furnished  by  means  of  either  accompanying  comments 
or  supporting  schedules. 

d.  Indefinite  account  titles,  so  frequently  found  upon  a  set 
of  books,  may  be  changed  without  hesitation  when  a 
statement  is  prepared  upon  which  such  accounts  are  to 
appear. 

2.  Periodical  statements  should  be  prepared  in  as  uniform  a 
manner  as  possible,  so  that  ready  comparisons  may  be  made 
between  the  statements  of  the  different  periods. 

3.  Since  existing  conditions  may  take  a  statement  out  of  a 
general  grouping  and  place  it  in  a  particular  class  all  by 
itself,  one  should  follow  neither  a  stereotyped  form  nor  be 
adamantine  in  insisting  that  a  given  illustrative  statement 
form  never  should  be  varied;  to  do  so  would  seem  to  indi- 
cate more  or  less  incompetency,  or  at  least  a  narrow-minded 
viewpoint.  Naturally,  only  experience  will  teach  one  when 
such  a  change  should  be  made.  An  illogical  arrangement, 
even  when  the  figures  are  accurate  and  each  item  clearly 
defined,  will  make  it  impossible  for  a  statement  to  serve 
its  fullest  measure  of  usefulness.  Again,  those  who  examine 
a  statement  in  proper  form  and  logically  arranged  will 
secure  a  favorable  impression  of  the  ability  of  the  compiler, 


BALANCE  SHEET:  PROFIT  AND  LOSS  STATEMENT      295 

in  that  attractiveness  of  form  and  of  general  appearance 
will  be  the  first  qualities  impressed  upon  the  mind  of  the 
reader  when  the  latter  scrutinizes  such  a  statement. 

4.  Underscoring  and  indenting  individual  items  and  groups  of 
items,  so  as  te  indicate  relationships  between  items  and 
groups  of  items,  as  clearly  as  possible,  should  be  made  use 
of  at  all  times. 

5.  The  designation  given  to  statements  is  a  matter  of  choice, 
but  uniformity  therein  may  be  considered  a  necessity.  The 
writer,  for  example,  makes  use  of  the  following  designations: 

a.  Exhibit.  This  is  a  statement  which  stands  by  itself 
independent  of  all  others.  The  term  is  followed  by  a 
letter  to  designate  the  order  in  which  the  exhibit  comes; 
for  example: 

i.  Balance  Sheet— Exhibit  A. 
ii.  Statement  of  Profit  and  Loss— Exhibit  B. 
iii.  Statement  of  Cost  of  Manufacture  and  of  Manu- 
factured Product  Sold— Exhibit  C. 

b.  Schedule.  This  is  a  statement  which  is  subordinate  to  an 
independent  statement.  The  term  is  followed  by  a  num- 
ber to  designate  the  order  in  which  the  schedule  comes, 
as:  Schedule  1,  etc. 

c.  Statement,    This  is  a  statement  which  is  subordinate  to 

a  schedule.    Each  carries  a  designating  number. 

Other  methods  of  designation  may  be  used  and,  at  times, 
should  be  used. 

6.  Attempt  to  place  yourself  in  the  client's  shoes,  so  to  speak, 
and  criticize  your  work  from  his  point  of  view. 

Balance  Sheet  Title.— One  object  of  keeping  a  set  of  books 
accurately  upon  sound  accounting  principles  for  a  business  enter- 
prise is  te  permit  its  actual  financial  condition  to  be  ascertained 
at  any  time.  Such  condition  is  evidenced  by  the  value  of  the 
assets  owned,  the  actual  or  estimated  value  of  all  liabilities,  and 
the  surplus  of  one  of  these  groupings  over  the  other  which 
represents  net  worth  or  insolvency.  The  second  object  of  keep- 
ing such  a  set  of  records  is  te  secure  a  summary  of  the  operations 
by  which  this  net  worth  or  insolvency  has  been  created,  increased 
or  diminished.  ' 


296 


ADVANCED  ACCOUNTING 


k 


The  formal  title  given  to  such  a  statement  of  assets  and  lia- 
bilities, prepared  from  the  books  properly  adjusted,  of  a  business 
as  at  a  given  moment  of  time  is  ''Balance  Sheet."  The  formal 
title  given  to  the  statement  summarizing  operations  by  which 
the  Balance  Sheet  net  worth  or  insolvency  has  been  created, 
increased,  or  diminished,  over  its  amount  as  of  a  prior  date,  in 
general,  may  be  "Profit  and  Loss  Statement."  It  is  concerning 
the  general  form  and  content  of  these  two  statements  that  the 
present  chapter  deals. 

It  should  be  remembered  that  in  the  strict  sense  of  the  word, 
a  Balance  Sheet  is  not  a  statement  of  facts,  but  only  an  opinion 
of  some  one  regarding  the  items  contained  in  it.  It  is  an  approxi- 
mation to  facts,  the  degree  of  definiteness  and  accuracy  th(»reof 
depending  upon  the  skill  and  accuracy  with  which  the  estimates 
are  made. 

Whenever  a  statement  is  prepared  which,  by  common  under- 
standing, may  be  called  a  Balance  Sheet,  many  accountants, 
especially  when  the  enterprise  under  review  is  of  considerable 
size,  will  use  the  title  General  Balance  Sheet,  rather  than  merely 
Balance  Sheet.  In  such  event,  one  who  reads  may  be  led  to 
assume  that  the  two  statements  differ  one  from  the  other.  As  a 
matter  of  fact,  as  the  meaning  of  both  titles  ordinarily  is  under- 
stood, no  such  difference  exists.  Since  one  title  does  not  appear 
to  be  more  formal  than  the  other, — in  that  all  Balance  Sheets 
present  the  financial  condition  of  a  business  as  a  whole,  as  at  a 
particular  moment  of  time, — it  seems  logical  to  adopt  one  or  the 
other  title  and  use  this  exclusively.  Again,  since  general  condi- 
tion is  shown  by  a  Balance  Sheet,  even  though  the  title  does  not 
contain  the  word  "General,"  the  shorter  title  would  seem  to  be 
the  preferred  one  to  use. 

Balance  Sheet  Form. — ^The  form  of  the  Balance  Sheet  is  not 
an  essential  feature,  except  insofar  as  it  has  been  discussed  above 
in  the  section  on  preliminary  suggestions.  Any  statement  is  a 
Balance  Sheet  which  contains  only  the  assets  and  liabilities  as 
found  on  the  Ledger.  The  variations  in  form  may  be  indicated 
as  under: 

1.  Account  form.  Hereunder,  the  Balance  Sheet  is  made  in 
one  table,  in  which  the  items  are  arranged  on  each  side  in 
the  order  determined  by  their  character  as  current  or  fixed. 


BALANCE  SHEET:  PROFIT  AND  LOSS  STATEMENT      297 

Although  accountants  differ  as  to  whether  the  current  or 
fixed  items  should  be  placed  first,  both  sides  should  follow 
the  same  method  of  set  out. 

2.  Double  account  form.  Hereunder,  the  Balance  Sheet  is 
made  in  two  tables.  In  the  first  table  the  fixed  liabilities 
of  capital,  surplus,  and  bonds  are  placed,  offset  by  the 
fixed  assets.  The  difference  secured  will  show  how  much  of 
the  capital  and  surplus  has  been  invested  permanently. 
This  difference,  or  balance,  is  brought  down  into  the  second 
table  as  the  amount  of  active  or  free  capital  which  is  avail- 
able for  carrying  on  the  operations  of  the  business.  In  this 
table  are  listed  the  current  liabilities  and  assets.  This  form 
of  Balance  Sheet  is  not  ordinarily  used,  but  would  seem  to 
be  an  extremely  desirable  form  to  show  the  fact  that  the 
business  needs  more  active  capital 

3.  Report  or  running  form.  Hereunder,  the  assets  are  listed 
and  their  total  extended;  under  them  the  liabilities  are  listed 
and  their  total  extended  and  deducted  from  the  total  of  the 
assets.  The  final  figure  secured  represents  the  business  net 
worth,  which  then  is  set  out  below  as  it  appears: 

a.  In  the  capital  accounts  of  a  partnership,  or 

b.  In  the  capital  stock  and  surplus  accounts  of  a  corpora- 
tion. 

Arrangement  of  Balance  Sheet  Items:  Account  Form  of 
Statement.— Two  general  methods  are  used  in  arranging  the 
Items  upon  the  account  form  of  Balance  Sheet.  Each  one  of 
these  is  commented  upon  briefly  below: 

1.  Common  and  usual  arrangement.  Hereunder,  the  assets  are 
arranged  as  nearly  as  possible  in  the  order  of  their  realiza- 
bihty,  and  the  liabilities  in  the  order  in  which  they  are 
payable,  the  net  worth  being  set  out  last.  From  the  stand- 
pomt  of  a  bank  or  of  a  creditor  this  arrangement,  under 
which  the  current  assets  are  displayed  at  the  top  on  the  left 
side,  and  the  current  liabilities  displayed  opposite  thereto 
at  the  top  on  the  right  side,  permits  of  a  ready  comparison 
between  the  two  groups.  Likewise,  hereunder  it  may  be 
advisable  to  set  out  the  net  worth  in  one  amount,  as  where 
the  Balance  Sheet  is  intended  for  a  prospective  purchaser. 


298  ADVANCED  ACCOUNTING 

A  Balance  Sheet  arranged  accordingly  might  appear  about 
as  follows  for  a  fairly  large  corporation: 


Liabilities: 

Current  LiabUities 

Funded  Debt 

Deferred  Credits  (suspense  credits) 

Reserves 

Capital  Stock 

Surplus 


Assets: 

Current  Assets 
Investments  (permanent) 
Sinking  Fund  (investment  of  re- 
serves) 
Properties 

Good-will,  Patents,  etc. 
Deferred  Charges  (suspense  debits) 

2.  Public  Utility  method  of  presentation.  Hereunder,  the  fixed 
or  capital  assets  appear  first  opposed  opposite  by  capital 
stock  and  funded  debt.  Next,  the  other  assets  and  liabilities 
are  set  out  in  about  the  same  manner  as  above  shown,  the 
surplus  being  the  last  item  on  the  right  side.  This  method 
cannot  be  subject  to  criticism  in  any  way,  although  not 
particularly  common;  it  is  followed  almost  entirely  among 
public  utilities.  A  summary  form  of  Balance  Sheet  ar- 
ranged according  to  this  method  might  appear  about  as 
follows: 


Liabilities: 
Capital  Stock 
Funded  Debt 
Current  Liabilities 
Deferred  Credits  (suspense  credits) 
Reserves 
Surplus 


Assets: 
Properties 

Good-will,  Patents,  etc. 
Sinking  Fund  (investment  of  re- 
serves) 
Investments  (pjermanent) 
Current  Assets 
Deferred  Charges  (suspense  debits) 

Variations  from  the  above  are  many,  but  it  is  believed  that 
for  general  corporate  work  the  methods  shown  are  both  correct 
and  sufiicient,  at  least  for  the  present.  Two  later  chapters  will 
illustrate  certain  variations  therefrom,  as  well  as  subsequent 
sections  of  the  present  chapter. 

Nomenclature  For  Balance  Sheet  Captions.— The  first 
essential  in  clearness  is  that  each  Balance  Sheet  caption  should 
express  the  nature  of  the  items  thereunder  included.  Nothing 
absolutely  definite  exists  in  respect  of  the  headings  used  on  a 
Balance  Sheet  since  accountants  are  greatly  at  variance  relative 
thereto. 

Current  Assets.  Often,  this  term  is  used  synonymously  with 
that  of  quick  assets,  floating  assets,  and  liquid  assets.     Quick 


BALANCE  SHEET:  PROFIT  AND  LOSS  STATEMENT      299 

assets,  however,  as  a  Balance  Sheet  caption,  would  seem  to 
govern  a  lesser  group  of  assets  than  any  one  of  the  others, 
especially  if  one  refers  to  the  form  of  Balance  Sheet  proposed 
by  the  Federal  Reserve  Board  for  merchants  and  manufacturers, 
m  that  temporary  investments  in  securities,  notes  given  by  ofii- 
cers,  stockholders,  or  employees,  and  accounts  due  from  officers, 
stockholders,  or  employees  are  excluded  therefrom.  Since  it  is 
probably  safe  to  state  that  the  most  prominent  accounting  firms 
prefer  its  use  to  any  other  caption,  the  term  "Current  Assets" 
would  seem  preferable  to  all  the  other  possibilities  so-called 
synonymous  therewith. 

The  items  included  under  Current  Assets  may  be  grouped 
about  as  follows: 

1.  Cash. 

2.  Notes  and  accounts  receivable.  These  are  intermediary 
instruments  by  means  of  which  the  conversion  into  cash 
is  made. 

3.  Short  term  and  realizable  investments  in  securities  (usually 
at  market  value)  held  only  until  an  outlet  is  found  for  the 
surplus  cash  either  in  the  extension  of  business  activities 
or  in  the  divisions  of  profit. 

4.  Inventories.  These  are  the  properties  which  by  the  aid  of 
the  capital  assets  continuously  are  being  converted  from  one 
form  into  another,  with  the  purpose  of  earning  a  profit  by 
later  sale  and  conversion  into  cash. 

In  fact,  all  items  readily  convertible  into  cash,  representing 
values  in  which  an  enterprise  operates,  available  for  the 
purpose  of  financing  the  current  operations  or  turnover,  may 
be  classed  as  current  assets. 

Capital  Assets.  This  item  is  synonymous  with  that  of  fixed 
assets,  covering  such  items  as  plant,  long-term  investments, 
franchises,  patents,  good-will,  etc.  The  capital  assets  relate  to 
the  acquisition  and  maintenance  of  the  permanent  plant  or  equip- 
ment with  which  an  enterprise  operates. 

Working  or  Working  and  Trading  Assets.  Many  accountants 
group  mventories  under  one  or  the  other  of  these  headings  in 
preference  to  including  them  under  current  assets.  Likewise, 
deferred  charges  to  operations  often  are  included  hereunder  (as 
insurance,  taxes,  etc.).    Expense  inventories  and  funds  may  be 


300 


ADVANCED  ACCOUNTING 


treated  as  working  assets;  again,  they  may  be  considered  as 
current  assets ;  again,  they  may  be  classed  as  deferred  charges. 

Liabilities.  Some  accountants  are  satisfied  thoroughly  to  use 
this  term  as  the  heading  for  the  right  side  of  the  Balance  Sheet; 
others  will  insist  that  this  is  in  error  and  that  such  heading 
should  be  Liabilities  and  Capital.  Whether  or  not  capital  is  an 
accountability  or  a  liability  should  be  of  small  consequence  to 
the  student  of  advanced  accounting.  The  discussion  thereon  is 
more  academic  than  practical.  Well  established  practice  should 
become  the  rule  and  guide  of  one's  actions  after  one  reaches  the 
turning  point  at  which  he  may  be  considered  an  advanced  stu- 
dent; let  facts  be  facts,  and  eliminate  whatever  is  non-essential 
and  mere  quibble. 

Accrued  Liabilities.  Items  such  as  wages,  interest,  and  taxes 
accrued  are  grouped  either  under  the  heading  of  "Current  Lia- 
bilities" or  separately  set  out  under  the  caption  of  "Accrued 
Liabilities."  If  an  accrual  be  a  liability,  common  sense  would 
seem  to  indicate  or  dictate  that  it  should  be  so  considered; 
although  Federal  taxes  often  are  set  out  as  Reserve  for  Federal 
Taxes,  they  represent  an  accrued  liability  and,  in  short,  ought 
to  be  so  considered. 

Reserves.  Ordinary  reserves,  as  for  depreciation,  and  for 
doubtful  accounts,  are  not  liabilities,  since  they  measure  actual 
or  estimated  reduction  in  asset  values.  Therefore,  although  fre- 
quently grouped  under  the  liabilities  heading,  they  ought  better 
be  deducted  from  the  assets  to  which  they  apply.  Other  reserves, 
not  measuring  actual  or  estimated  asset  reduction,  rightly  may 
be  segregated  and  be  included  on  the  right  side  of  the  Balance 
Sheet. 

Deficit.  This  item  may  be  found  either  on  the  left  or  right 
side  of  the  Balance  Sheet.  Some  say  that  by  placing  it  on  the 
left  side,  it  is  considered  as  an  asset,  and  must  be  if  capital  is 
considered  as  a  liability.  Apparently,  another  academic  dis- 
tinction is  encountered  here  which  has  no  practical  worth.  Com- 
mon sense  will  not  consider  a  deficit  as  an  asset  even  though 
this  item  may  be  placed  among  the  assets;  likewise,  the  mere 
inflation  of  the  total  assets  figure  thereby  means  nothing,  since 
such  figure  has  no  interpretative  importance.  Many  Balance 
Sheets  show  the  deficit  among  the  assets  and  the  opinion  is  ven- 


BALANCE  SHEET:  PROFIT  AND  LOSS  STATEMENT     301 

tured  that  no  accountant  will  jeopardize  his  professional  stand- 
ing. It  he  has  one,  by  so  allocating  it 

in^Tr'  ^TV  ^^'^-^^'  ^^^^-°t  asset  of  cash  as  stated 
m  a  Balance  Sheet  presents,  if  any,  but  little  difficulty.  It  will 
consist  of  three  principal  variations : 

1.  Cash  on  current  deposit  with  banks. 

2.  Cash  on  restricted  deposit  with  banks  or  others 

3.  Cash  m  hands  of  ofl^cials. 

If  the  amount  of  available  cash  on  deposit  be  of  considerable 
size.  It  may  be  set  out  as  "Cash  on  Deposit"  or  "Cash  in  Bank"- 
f  not  of  sufficient  consequence  to  justify  separate  discrimination' 
the  cash  may  be  stated  as  just  -Cash."  If  the  cash  on  deposit 
consists  in  part  of  funds  held  for  special  purposes,  these  speci 
funds  may  be  stated  separately  from  the  current  fund  deposits 
In  case  an  overdraft  arises,  the  ordinary  method  would  be  to 
show  Its  amount  as  a  current  liability.  However,  sufficient  rea- 
son  may  exist  for  allocating  it  otherwise : 

1.  An  overdraft  on  one  bank  covered  by  outstanding  checks 
may  be  deducted  from  the  balance  shown  as  on  hand  in 
another  bank  where  this  latter  balance  is  greater  than  the 
amount  of  the  overdraft;  the  net  cash  balance  then  will  be 
extended  out  as  an  asset. 

2.  An  overdraft  on  one  bank  greater  in  amount  than  the  cash 
available  in  another  bank  would  be  sufficient  reason  for 
having  each  item  shown  separately  upon  the  Balance  Sheet- 
the  overdraft  should  be  set  out  as  a  current  liability  and 
the  debit  balance  of  a  smaller  amount  as  an  asset 

3.  A  book  overdraft  caused  by  entering  checks  in  advance  of 
having  them  sent  out  would  seem  to  permit  one,  as  of 
Balance  Sheet  date,  to  add  back  the  amount  of  checks  so 
entered  but  held  to  the  end  that  the  cash  balance  will  be 
replenished  thereby,  the  amount  so  added  back  being  off- 
set  by  a  credit  to  Accounts  or  Vouchers  Payable  account. 
I  he  above  reasoning  is  based  upon  the  fact  that  a  bank 
account  cannot  be  disposed  of  on  or  before  closing  date 
by  the  mere  drawing  of  checks;  to  do  so,  the  checks  actually 
must  have  been  mailed  prior  to  that  date.  Practically,  after 
a  check  has  been  mailed,  it  is  no  longer  considered  dis- 


IPi 


il 


1 


302 


ADVANCED  ACCOUNTINQ 


Separate  cash  deposits  available  only  for  interest  and  dividend 
payments,  for  capital  expenditure,  or  withdrawable  only  after  a 
date  certain,  should  be  stated  separately  with  complete  ex- 
planation as  to  the  nature  of  the  restriction,  and  the  offsets 
thereto,  if  any,  should  be  found  under  the  caption  of  current 
liabilities.  Sinking  fund  deposits  and  deposits  made  in  order  to 
secure  special  service  should  be  set  out  separately,  but  not  un- 
der current  assets.  Free  cash  balances  should  be  separated 
so  as  to  distinguish  between  cash  on  hand  and  bank  balances 
both  bearing  interest  and  not  bearing  interest. 

Working  funds  representing  cash  held  by  salesmen,  cashiers, 
etc.,  for  the  payment  of  current  expenses  or  for  making  pur- 
chases may  be  merged  as  part  of  general  cash  in  the  amount  of 
the  cash  actually  on  hand;  all  such  funds  may  be  lumped  and 
one  sum  shown  therefor,  or  they  may  be  indicated  separately. 

The  practice  of  keeping  the  Cash  Book  open  beyond  the  clos- 
ing date  so  that  entries  relating  to  receipts  and  payments  may 
be  made  at  a  date  later  than  the  closing  date  although  con- 
cerned with  transactions  of  dates  prior  to  the  closing  date, — so 
as  either  to  show  smaller  amounts  due  from  debtors  or  to 
creditors,  or  a  larger  cash  balance, — is  not  in  order  from  any 
point  of  view  in  that,  by  so  doing,  the  financial  position  as  of  the 
correct  closing  date  will  not  be  the  financial  position  shown 
thereunder. 

Current  Assets;  Notes,  Acceptances,  and  Accounts 
Receivable. — ^All  items  properly  grouped  under  this  caption 
should  be  both  current  and  liquid  to  the  end  that  the  aggregate 
will  be  realizable  at  total  face  value  within  a  definite  period 
of  time,  dependent  upon  the  nature  of  the  business.  The  assets 
hereunder  represented  day  by  day  and  in  the  ordinary  cours  e  of 
business  are  being  converted  continually  into  some  more  liquid 
and  available  asset,  as  cash;  in  turn,  this  enables  one  to  count 
upon  such  assets  as  a  source  from  which  corresponding  liabilities 
may  be  met  as  they  mature. 

Notes  receivable  and  trade  acceptances  receivable  art;  so 
essentially  similar  that,  in  general,  no  separation  need  be  made 
upon  the  Balance  Sheet  relative  thereto.  However,  if  a  con- 
siderable portion  of  the  notes  relates  to  loans  rather  than  to 
trade  activities,  their  amount  should  be  stated  separately.    Notes 


BALANCE  SHEET:  PROFIT  AND  LOSS  STATEMENT      303 

and  acceptances  receivable  which  have  been  discounted  may  be 
shown  upon  the  Balance  Sheet: 

1.  As  a  deduction  from  the  gross  amount  on  the  asset  side. 

2.  As  a  footnote. 

3.  As  a  current  liability. 

Since  notes  receivable  will  not  be  due  until  a  date  subsequent 
to  that  as  of  which  the  Balance  Sheet  is  prepared,  conservatism 
will  permit  one  to  reduce  their  amount  to  a  present  value: 

1.  If  a  note  be  for  a  fixed  sum  with  interest,  the  face  value 
shown  will  be  the  present  value. 

2.  If  a  note  be  for  a  fixed  sum  payable  without  interest,  it 
would  be  permissable  to  reduce  the  face  value  to  present 
value  by  charging  an  income  account  and  crediting  a  dis- 
count or  interest  reserve  account  with  the  interest  thereon 
from  Balance  Sheet  date  to  date  of  maturity. 

Again,  if  it  should  appear  for  a  given  case  that,  before  final 
collection,  a  material  portion  of  the  face  value  of  the  notes  will 
be  absorbed  by  collection  costs,  it  would  not  be  in  error  to  make 
provision  therefor  by  the  establishment  of  a  sufficient  reserve- 
however,  the  interest  accruing  upon  these  notes,  to  be  booked 
only  as  actually  received,  will  offset  this  collection  cost  to  some 
extent. 

Customers'  accounts  should  be  shown  upon  the  Balance  Sheet 
separate  from  the  accounts  covering  loans  or  advances.  In  any 
instance,  care  should  be  observed  to  designate  customers'  ac- 
counts receivable  as  such  rather  than  leave  it  to  the  reader  to 
decide  for  himself  whether  customers'  accounts  are  represented 
or  others. 

The  various  classes  of  accounts  receivable,  other  than  cus 
Wrs,  should  each  be  set  out  separately  under  proper  sub- 
headings provided  the  amount  thereof  is  sufliciently  large  to 
warrant  the  usefulness  of  this  added  information-  if  these 
amounts  are  not  large  all  may  be  merged  into  one  item  -Ac 
counts  Receivable-Others  (or  Sundry).  Customers'  accounts 
carrying  credit  balances  (net)  should  be  shown  as  a  current 
liability  either  separately  or  combined  with  the  Accounts  Pav- 
able — Trade.  ^ 

Loans  advanced  secured  by   accounts  receivable,-a  pledge 
thereof  against  such  loans,  are  common  at  the  present  time,  such 


304 


ADVANCED  ACCOUNTING 


Ml 

x 

0 


loans  being  made  up  to  about  eighty  per  cent,  of  the  value  of  the 
accounts  pledged.  Even  though  these  transactions  often  are  in 
the  form  of  actual  sales,  it  is  well  to  consider  the  case  as  a  loan. 
Therefore,  the  accounts  pledged  may  be  carried  as  an  asset,  and 
the  balance  due  the  pledgee  or  lender  may  be  set  out  as  a 
liability.  When  such  condition  is  encountered,  the  Accounts 
Receivable — Customers  should  be  shown  on  the  Balance  Slieet 
divided  between  those  pledged  and  those  unpledged. 

The  handling  of  reserves  for  doubtful  accounts  receivable 
varies  among  accountants.  The  following  treatment,  howe\'er, 
is  advocated: 

1.  If  the  reserve  covers  accounts  specifically  regarded  as  bad 
or  doubtful,  the  amount  thereof  should  be  handled  as  a 
deduction  from  the  accounts  receivable. 

2.  If  all  bad  or  doubtful  accounts  have  been  written  off  the 
books,  and  the  reserve  provided  represents  merely  a  pro- 
vision against  contingencies,  it  would  seem  proper  then  to 
consider  such  a  reserve  as  a  pure  appropriation  of  surphis, 
in  which  event  its  amount  would  be  shown  on  the  right  side 
of  the  Balance  Sheet. 

Reserves  for  cash  discounts  may  represent  the  following  of  a 
conservative  policy  upon  the  part  of  a  concern  setting  them  up, 
but  since  they  do  not  become  a  charge  at  the  time  a  sale  is  made, 
only  when  taken,  their  use  would  not  seem  to  be  exactly  in 
order.  Reserves  covering  trade  discounts,  freight,  allowances, 
etc.,  properly  may  be  deducted  from  the  assets.  It  should  be 
remembered  that  trade  discounts  ought  always  to  be  deducted 
when  the  charge  is  made  upon  the  books. 

Current  Assets:  Short  Term  Investments. — The  classes  of 
investments  to  be  grouped  hereunder  represent  securities  held 
under  a  temporary  disposal  of  surplus  cash,  or  those  acquired  in 
payment  of  debts  or  otherwise,  and  held  for  realization  at  a  suit- 
able price;  no  question  should  exist  as  to  their  marketability, 
and  the  maturity  dates  thereof  should  not  enter  into  considera- 
tion. These  investments  have  no  relation  to  the  business  what- 
ever, and  their  disposal  should  be  possible  without  an  inter- 
ference in  any  way  with  the  earning  capacity  of  the  business, 
other  than  a  loss  of  the  income  thereon. 

If  they  represent  investments  more  or  less  permanent,  or  a 


BALANCE  SHEET:  PROFIT  AND  LOSS  STATEMENT      305 

^honMt"^  or  controlling  interest  in  some  other  enterprise,  they 
should  be  considered  as  a  capital  asset.  The  book  value  at  which 
these  securities  are  carried,  as  current  assets,  should  not  be  far 
in  excess  of  their  market  value.  When  the  excess  is  small  in 
amount,  the  true  statement  of  the  assets  is  not  affected  ma- 
erially  thereby;  however,  when  a  cost  valuation  is  used  under 
such  a  condition,  it  would  be  wise  to  indicate  somewhere  upon 
the  Balance  Sheet  whatever  depreciation  in  value  actually  does 

mTv  h.  f  ?;  ^"?*"^*T  ^"  ^^'  ^'•""  °f  marketable  securities 
may  be  dealt  with  by  the  creation  of  a  Reserve  for  Fluctuation 
m  Investment  account: 

1.  This  being  set  up  out  of  realized  or  estimated  profits   on 
investments,  or  ' 

account     Such  a  reserve  never  should  show  a  debit  bal- 
ance; the  charges  or  credits  thereto  always  should  be  suffi- 
cient so  that  by  its  use  the  asset  will  be  maintained  at 
market  value,  this  being  lower  than  cost 
Any  securities  pledged  should  be  shown  upon  the  Balance 

Sheet  as  such     Short  term  investments,  if  possible,  should  be 

shown  upon  the  Balance  Sheet  by  name 
Current  Assets:  Accrued  Interest.-This  item  may  be  shown 

Ufx>n  the  Balance  Sheet  either  as  one  amount  or  separate  accorl 

mg  to  the  assets  responsible  for  such  accrual 

..^"^'H^T'^'-  I"^««t°"««-Too  much  information  con- 
cermng  this  item  cannot  be  shown  upon  the  Balance  Sheet 
Th^  Balance  Sheet  of  a  manufacturmg  concern,  usually,  Jm 
group  the  mventories  as:  j^   wm 

1.  Finished  goods. 

2.  Goods  in  process. 

3.  Materials  and  supplies.     This  latter  item  well  might  in- 
chide  all  supplies  of  a  tangible  nature  rather  than  placing 
those  of  a  general  character  under  the  caption  of  "De 
ferred  Charges." 

If  any  merchandise  be  pledged,  the  Balance  Sheet  should 

i^ir;  'r'  •''"r"  P^^^^^^  ^^^''•^^  mventoriefto t;^ 
possible  decline  m  value  or  interdepartmental  profit  should  bl 
deducted  from  the  asset.  ^ 

Goods  out  on  consignment,  if  considerable  in  amount,  should 


306 


ADVANCED  ACCOUNTING 


h 


be  shown  separately.  Samples  out  may  not  be  inventoried  at 
all;  if  inventoried,  state  separately.  Goods  received  upon  con- 
signment have  no  place  upon  the  Balance  Sheet;  all  advances, 
however,  in  connection  therewith,  should  be  stated  separately. 

The  carrying  charges  of  merchandise,  storage,  etc.,  are  legiti- 
mate additions  to  the  cost  of  goods  on  hand  up  to  the  point 
where  the  entire  value  of  such  goods  equals  their  market  value. 
Carrying  charges  either  may  be  combined  with  the  rest  of  the 
goods  value  or  may  be  shown  separately. 

Accurate  inventory  valuations  are  of  vital  import  to  the  se- 
curement  of  a  correct  Balance  Sheet.  Therefore,  it  may  not 
be  amiss  here  to  include  a  few  general  remarks  relative  to  in- 
ventory valuations,  since  this  is  a  matter  of  considerable  diffi- 
culty involving  many  important  questions.  Until  an  article 
either  has  been  sold  or  exchanged,  no  profit  should  be  considered 
thereon;  a  paper  profit  never  may  be  realized. 

In  general,  since  a  Balance  Sheet  should  show  the  true  financial 
condition  of  a  going  concern,  it  may  be  incorrect  to  value  an 
inventory  at  actual  cost  in  that  actual  cost  may  represent  more 
or  less  than  the  market  value;  the  result,  therefore,  would  be 
either  to  overstate  or  understate  the  asset-s.  However,  actually 
to  change  a  book  valuation  at  cost  to  a  market  valuation  is 
not  in  order,  so  far  as  the  books  are  concerned,  because  the 
profit  or  loss  thus  set  up  never  actually  may  be  realized  on  ac- 
count of  further  changes  in  market  value.  But  since  no  credit 
shall  be  taken  for  profit  until  the  latter  is  realized,  whereas  a 
possible  loss  in  the  disposal  of  what  remains  unsold  should  be 
provided  against  out  of  profits  actually  realized  on  sales  already 
made,  it  is  considered  as  good  accounting  where  cost  exceeds 
market  to  set  up  a  reserve  to  bring  the  cost  value  down  for 
Balance  Sheet  purposes;  since  this  asset  has  been  acquired  only 
for  the  purpose  of  realization  at  a  profit,  and  not  to  be  held 
for  the  permanent  uses  of  the  company,  a  drop  in  the  market 
price  means  a  proportionately  less  return  than  otherwise  would 
be  the  case.  On  the  other  hand,  it  would  seem  logical  to  write 
up  inventory  values  as  the  market  advances  if,  when  the  mar- 
ket drops,  such  values  are  written  down;  however,  the  practice 
is  otherwise.  To  begin  with,  profits  under  any  event  are  not  yet 
realized,  and  if  profit  be  taken  on  a  written  up  valuation,  the 


BALANCE  SHEET:  PROFIT  AND  LOSS  STATEMENT      307 


market  may  fluctuate  adversely  before  realization  to  the  end 
that  an  actual  loss  may  result;  also,  an  understatement  of  profit 
not  only  delays  a  profit  distribution,  but  at  the  same  time  it  con- 
serves values  as  against  an  overstatement  which  may  operate 
disastrously.  Hence,  the  accepted  rule  for  valuing  current  as- 
sets, "cost  or  market,  whichever  is  the  lower."  However,  since 
the  cost  prices  of  inventory  assets  do  not  fluctuate  to  a  great 
extent  under  normal  business  conditions,  one  may  say,  in  gen- 
eral, that  these  items  will  be  set  up  at  their  cost. 

There  are  five  essential  elements  in  ascertaining  correct  profits 
with  relation  to  inventories  on  hand: 

1.  The  quantities  on  hand  must  be  determined  correctly.    This 
may  or  may  not  be  difiicult.    It  will  not  be  difficult  where 
a  plant  can  be  closed  down  entirely  until  the  inventory  is 
taken;  again,  but  little  difficulty  should  be  encountered 
where  a  perpetual  inventory  record  is  kept  which  is  checked 
up  and  adjusted  from  time  to  time  with  the  actual  quantity 
on   hand.     The  inventory   count  will   entail   considerable 
difficulty  where  the  work  involved  consumes  considerable 
time  and  where  the  plant  cannot  be  shut  down.    Here  a 
systematic  plan  must  be  laid  out  beforehand  under  which 
duplication  will  be  prevented.     Incoming  stock  not  to  be 
counted  must  be  segregated ;  outgoing  stock  should  be  taken 
from  that  on  hand  but  not  yet  counted.     Bulk  materials 
carried  in  piles  must  be  more  or  less  estimated  unless  some 
sort  of  a  book  inventory  by  quantities  be  kept  in  connection 
therewith.    The  apparent  contents  of  a  pile  will  be  affected 
by  moisture  or  by  irregularities  in  the  ground  surface.    To 
secure  some  degree  of  accuracy,  the  measurement  of  any 
such  pile  should  be  made  by  two  persons  independently 
of  each  other.    Work  in  process  cannot  be  inventoried  satis- 
factorily unless  some  attempt  has  been  made  to  record 
the  labor  and  material  put  in  and  the  finished  product 
taken  out,  due  consideration  being  given  to  the  element 
of  wastage.    The  quantity  of  scrap  material  on  hand  never 
can  be  valued  with  any  degree  of  accuracy;  and  under  all 
circumstances  a  liberal  allowance  should  be  made  against 
overvaluation. 
2.  The  actual  cost  of  goods  completed  or  in  process  of  manu- 


308 


ADVANCED  ACCOUNTING 


facture  must  be  ascertained  as  accurately  as  possible.  This 
point  brings  up  the  subject  of  cost  accounting  which  can- 
not be  treated  in  the  present  volume,  it  being  a  subjecst 
requiring  separate  study. 

3.  The  clerical  work  in  connection  with  (1)  and  (2)  must 
be  performed  accurately. 

4.  Proper  provision  must  be  made  in  the  valuations  to  take 
care  of  reductions  in  market  prices  whereby  market  price 
drops  below  cost. 

5.  Proper  provision  must  be  made  for  all  stock  which,  for 
any  reason,  is  apt  to  prove  unsaleable. 

Investments.— Long-term  investments  should  be  placed  here- 
under, as  investments  of  general  reserves,  real  estate  not  held 
for  plant  purposes,  advances  to  constituent  companies,  etc.  If 
these  should  be  included  among  the  current  assets,  it  would  be 
impossible  to  secure  a  clear  view  of  actual  facts.  Securities 
may  be  carried  at  book  value,  but  where  b<3ok  value  is  in  excess 
of  market  value,  as  determined  from  reliable  financial  sources, 
such  difference  should  be  shown  in  some  way.  Securities  j)ledged 
should  be  shown  separately  in  some  manner  upon  the  Balance 
Sheet. 

These  permanent  investments,  in  general,  control  some  essen- 
tial part  of  the  activities  carried  on.  The  distinction  between 
investments  as  current  assets  and  those  considered  as  capital 
or  fixed  assets  is  a  most  important  one.  The  financial  position 
of  an  enterprise  may  be  placed  in  jeopardy  in  that  in  their  se- 
curement  it  is  necessary,  usually,  to  withdraw  a  portion  of  the 
current  assets  from  the  general  use  of  the  business  and,  by  so 
doing,  these  current  assets  are. diverted  from  the  purpose  for 
which  intended,— the  rapid  conversion  from  cash  into  saleable 
products  and  so  back  again  into  cash.  Unless,  in  the  first  in- 
stance, the  current  assets  are  more  than  suflicient  for  all  needs, 
the  conversion  of  any  portion  thereof  into  assets  of  a  permanent 
nature  takes  that  much  of  the  current  assets  out  of  current 
use  which  in  turn  means  that  either  the  operations  must  be 
reduced  or  the  liabilities  increased. 

When  an  investment  has  been  made  to  secure  control  of  the 
operations  of  another  business,  the  method  of  handling  may  be 
indicated  about  as  follows: 


BALANCE  SHEET:  PROFIT  AND  LOSS  STATEMENT      309 

1.  If  the  interest  owned  is  substantially  the  whole,  the  Bal- 
ance Sheets  of  all  such  interests  should  be  consolidated 
with  that  of  the  company  so  controlling  into  what  is  known 

as  a  Consolidated  Balance  Sheet  (see  post.  Chap.  13). 

2.  If  the  interest  owned  is  not  substantial  but  still  represents 
a  controlling  interest,  the  investment  should  be  treated  as 
an  asset. 

When  an  investment  has  been  made  to  secure  the  right  to 
use  some  connection  or  facilities  held  by  another,  needed  under 
the  present  policy  of  activities,  the  valuation  will  be  at  cost 
rather  than  otherwise,  assuming  at  least  that  such  cost  reflects 
the  present  value  of  such  connections  and  facilities  from  the 
standpoint  of  use. 

The  special  investment  of  funds  set  aside  for  the  different 
reserves  classed  as  appropriated  surplus  is  common.  Since  the 
fluctuation  in  the  value  of  these  investments  affects  only  the 
reserves  m  question,  and  since  profits  or  losses  cannot  be  deter- 
mmed  definitely  until  the  reserves  are  needed  and  the  invest- 
ments sold,  it  is  usual  to  carry  them  at  cost  ignoring  all  fluctu- 
ations of  a  temporary  nature  and  of  a  relatively  small  amount 
Where  such  funds  have  been  invested  in  the  company's  own  se- 
curities rather  than  in  those  of  some  outside  corporation  such 
investment,  from  the  point  of  view  of  a  Balance  Sheet,  should 
be  eliminated  from  both  the  asset  and  the  liability  sides  so 
far  as  the  totals  are  concerned. 

Sinking  Fund.— The  components  of  a  sinking  fund  should  be 
set  out  upon  the  Balance  Sheet  separately  and  whatever  securi- 
ties are  there  included  should  be  described  fully.  If  some  of 
the  company's  own  bonds  have  been  purchased  from  the  total 
amount  outstanding,  for  the  redemption  of  which  the  sinking 
fund  was  created,  the  amount  thereof  may  be  deducted  from  the 
total  bonds  shown  as  having  been  issued.  When  these  bonds 
however,  have  been  cancelled,  and  no  longer  bear  interest,  the 
total  amount  outstanding  should  be  reduced  actually  by  such 
cancellations.    The  components  of  a  sinking  fund,  usually,  will 

Properties.-The  items  hereunder  are  variously  grouped  as 
^Troperty,"  and  'Troperty  and  Plant."  If  the  phyLaTprop! 
erty  consists  of  land,  buildings  and  equipment,  either  of  the 


310 


ADVANCED  ACCOUNTING 


above  terms  would  seem  proper.  If  outside  investments  in  real 
estate  are  found  and  are  carried  separately,  the  property  per- 
taining specifically  to  the  plant  should  be  classed  as  "Plant 
Properties."  Also,  if  no  land  and  buildings  are  owned  for  j)lant 
purposes,  only  equipment  remains,  and  this  should  be  designated 
as  "Equipment." 

The  basis  of  Balance  Sheet  valuation  of  each  of  these  items 
should  be  indicated, — cost,  cost  less  depreciation,  reproduction 
cost  appraised,  or  sound  value  appraised.  If  an  appraised  value 
affects  the  surplus  by  increasing  it,  the  increase  therein  should 
be  set  out  separately  since  distributable  surplus  does  not  exist 
thereunder;  appreciation  or  inflation  in  property  values  does  not 
represent  distributable  profit. 

Since  depreciation  does  not  apply  to  land,  except  in  rare 
cases,  the  depreciation  reserves  are  connected,  in  general,  only 
with  the  buildings  and  equipment.  They  should  be  deducted 
from  the  assets  to  which  they  apply,  in  detail  or  in  total,  and 
should  not  be  carried  among  the  liabilities  on  the  right  side 
of  the  Balance  Sheet,  unless  the  company  be  a  public  utility.  In 
the  latter  event,  it  is  probable  that,  by  law,  the  reserves  must 
be  placed  among  the  liabilities.  Where  no  depreciation  is  shown 
or  is  to  be  taken,  such  fact  should  be  set  out  in  a  carefully 
worded  footnote;  the  same  would  be  true  if  it  is  deemed  that 
the  depreciation  provision  is  not  adequate. 

Land  and  land  improvements  represent  either  a  fee  owner- 
ship or  the  enjoyment  of  such  properties  under  a  lease.  In  the 
former  event,  the  valuable  life  of  expenditures  made  goes  hand 
in  hand  with  the  life  of  the  improvement;  in  the  latter  case,  a 
limit  exists  equal  to,  more  than,  or  less  than,  that  life.  Land 
improvements  cover  all  expenditures  that  add  a  long  term  or 
permanent  value  and,  in  general,  they  are  not  subject  to  de- 
preciation from  wear  and  tear,  although  they  may  be  subject  to 
provision  for  abandonment  or  obsolescence;  the  exceptions  here 
to  the  general  rule  may  be  set  out  as  under; 

1.  Expenditures  upon  growing  timber. 

2.  Expenditures  related  to  mine  development. 
Expenditures  relative  to  these  exceptions  must  be  considered 

especially  with  regard  to  the  life  of  the  property  in  relation  to 


BALANCE  SHEET:  PROFIT  AND  LOSS  STATEMENT     311 

which  they  have  been  incurred.  Mining  expenditures  must  be 
written  off  either  over  the  term  set  for  the  exhaustion  of  the 
minerals  or,  if  the  life  is  less  than  such  term,  over  the  shorter 
period.  Expenditures  upon  growing  timber  may  be  capitalized 
only  to  the  extent  that  a  fair  certainty  exists  that  the  ultimate 
value  secured  upon  sale  will  cover  at  least  the  original  cost, 
later  expenditures  for  care  and  upkeep  and  cost  of  marketing! 
Uncertain  catastrophes  incident  to  mining  and  timber  operations, 
as  fires  and  floods,  are  capital  losses  to  be  guarded  against  by 
the  creation  of  special  reserves  out  of  profits  previously  earned. 
Buildings  and  structures  have  a  long  life,  as  a  rule,  but  one 
that  some  day  must  end;  therefore,  they  are  subject  to  regular 
depreciation. 

All  the  permanent  facilities  required  and  used  directly  in  any 
activity,  as  machinery,  fixed  tools,  etc.,  must  be  kept  up  con- 
tinuously and  be  replaced  from  time  to  time;  therefore,  they 
are  subject  to  depreciation  for  obsolescence  as  well  as  for  wear 
and  tear. 

Movable  equipment,  equipment  continuously  moved  from 
place  to  place  as  demand  for  their  use  requires,  have  but  little 
obsolescence,  but  heavy  wear,  tear,  and  loss  which  makes  fre- 
quent replacement  necessary.  Either  heavy  depreciation  there 
agamst  must  be  provided,  or  all  expenditures,  including  what- 
ever amount  is  necessary  to  reduce  the  balance  to  inventory 
value,  are  written  off  as  an  operation  cost;  in  the  latter  event, 
they  are  treated  as  working  assets. 

Furniture  and  fixtures  represent  an"  asset  of  little  value 
except  when  actually  in  use,  even  though  the  estimated  life 
may  be  fairly  long.  The  carrying  value  thereof  may  be  re- 
duced year  by  year  by  a  gradual  reduction  charge,  as  ofttimes 
IS  done,  or  better  yet,  the  reduction  may  be  abrupt  in  char- 
acter the  asset  being  written  down  to  a  nominal  or  breakup 
value  as  quickly  as  possible. 

Patterns,  drawings,  dies,  etc.,  are  difficult  of  evaluation  but 
conservatism  should  prompt  one  to  make,  in  connection  there- 
with, liberal  allowance  for  wear  and  tear  and  other  waste  due 
to  operation.  While  in  use,  they  may  be  assumed  as  being 
worth  their  cost,  whereas,  when  use  ceases,  because  of  changes 
in  design,  they  are  worth  little  or  nothing. 


312 


ADVANCED  ACCOUNTING 


Good-will,  Patents,  etc. — These  are  intangible  assets  and 
should  be  shown  separately  upon  the  Balance  Sheet  as  such. 
If  a  separation  between  the  tangible  and  intangible  assets  can- 
not be  made  to  the  end  that  these  items  must  be  stated  in  com- 
bination with  the  tangibles,  great  care  should  be  observed  to 
make  certain  that  one  who  reads  will  understand  that  such  in- 
tangibles are  actually  included. 

These  intangible  assets  are  very  similar  to  one  another.  A 
patent  is  granted  for  a  term  of  years,  and  the  amount  paid  there- 
for, theoretically  should  be  written  off  against  the  profits  earned 
during  those  years.  However,  cognizance  must  be  taken  of  the 
fact  that  something  else  may  develop  to  change  this  attitude  of 
consideration : 

1.  Before  the  original  patent  has  expired,  either  a  virtual 
monopoly  may  be  built  up  or  the  business  may  be  so  pros- 
perous that  its  original  cost  may  be  replaced  by  the  rea- 
sonable value  of  the  good-will. 

2.  During  the  life  of  the  original  patent,  many  others  may  be 
taken  out,  each  representing  a  modification  of  some  kind 
which  has  the  effect  of  extending  the  life  of  the  original 
patent  in  an  improved  form.  The  cost  of  these  later  pat- 
ents may  be  relatively  small  as  compared  to  the  cost  of  the 
original  one. 

Good-will  must  be  discussed  rather  fully  in  a  later  chapter 
concerned  with  mergers  and  consolidations.  Therefore,  but  little 
need  be  said  concerning  this  asset  at  the  present  moment.  As 
long  as  the  earnings  of  an  enterprise  equal  those  contemplated 
at  date  of  purchase,  one  cannot  well  say  that  there  has  been 
any  depreciation  in  its  value  or  that  any  provision  for  such 
depreciation  need  be  made.  However,  if  the  profits  have  dropped 
seriously,  the  value  of  the  asset  of  good-will  likewise  has 
dropped,  yet  whether  or  not  provision  should  be  made  for  such 
reduction  in  value  is  a  practical  problem  not  easily  solved  en- 
tirely from  a  theoretical  point  of  view;  the  profits  may  be  so 
much  reduced  that,  even  though  the  value  of  good-will  is  ques- 
tionable, it  will  not  be  practicable  to  make  such  provision.  The 
value  of  good- will  depends  considerably  upon  profits  earned,  and 
the  fluctuation  therein  is  a  result  of,  not  a  cause  of,  earning 
profits. 


BALANCE  SHEET:  PROFIT  AND  LOSS  STATEMENT     313 

Franchises  are  either  perpetual  or  for  a  fixed  term.  Where 
perpetual,  the  same  considerations,  in  general,  apply  as  relate 
to  valuing  good-will.  Where  only  for  a  fixed  term,  a  reasonable 
provision  should  be  made  each  year  covering  the  reduction  in 
value,  even  though  the  actual  amount  thereof  may  not  be  ascer- 
tainable due  to  the  fact  that  they  may  be  renewable  at  the  end 
of  the  present  term. 

Deferred  Charges.— These  items  are  classed  variously  as 
''Deferred  Charges,"  ''Deferred  Debits,"  "Deferred  Assets,"  and 
"Prepaid  Expenses."  The  first  two  titles  are  preferable  to  the 
latter  two  in  that  the  last  two  will  not  be  appropriate  under  all 
conditions.    In  general,  deferred  charges  are  of  two  kinds: 

1.  Expenditures  to  be  absorbed  by  future  operations. 

2.  Items  held  in  suspense  awaiting  final  decision  as  to  allo- 
cation. 

Ofttimes,  working  funds,  special  deposits,  and  miscellaneous 
advances  will  be  included  hereunder. 

Current  Liabilities:  Notes  and  Acceptances  Payable.— 
Notes  payable  based  upon  loans  should  be  shown  separately  from 
notes  and  acceptances  payable  to  trade  creditors.  Secured  ob- 
ligations may  be  thus  indicated  although  where  specific  property 
be  pledged,  a  statement  relative  to  the  pledge  will  be  shown 
m  connection  with  the  asset  in  question.  It  may  be  advisable, 
also,  to  summarize  obligations  by  maturity  dates. 

Current  Liabilities:  Accounts  Payable.— These  should  be 
grouped  by  classes,— trade  creditors,  advances,  loans,  etc.  Credit 
balances  in  customers'  accounts,  where  no  debit  balance  with  the 
same  customers  exist,  should  be  shown  as  a  current  liability 
usually  mcluded  with  the  other  trade  accounts  payable  De- 
ductions on  account  of  cash  discounts  which  may  be  taken  ought 
not  to  be  considered.  If  any  accounts  payable  be  omitted  with 
their  offsetting  assets,  which  is  of  infrequent  occurrence,  a  foot- 
note should  be  included  describing  such. 

Provision  should  be  made  always  for  all  known  liabilities 
even  where  the  exact  amounts  are  not  ascertainable.  Some  sort 
of  approximation  always  can  be  made  and,  where  possible,  such 
items  should  be  allocated  as  current  liabilities;  as  a  real  liability 
exists,  such  items  should  not  be  set  out  as  part  of  surplus  or 
as  a  reserve.  k  *«  "* 


314 


ADVANCED  ACCOUNTING 


Current  Liabilities:  Dividends  Payable. — Dividends  de- 
clared but  not  yet  paid  as  of  Balance  Sheet  date  are  current 
liabilities.  Dividends  on  preferred  capital  stock  should  be 
handled  as  above  if  the  date  of  the  Balance  Sheet  is  immediately 
prior  to  date  of  payment;  otherwise,  the  amount  thereof  should 
be  allocated  as  a  reserve. 

Current  Liabilities :  Wages,  Taxes,  and  Interest  Accrued. 
— ^Wages  accrued  represent  either  the  actual  or  estimated  amount 
of  wages  earned  as  a  Balance  Sheet  date,  but  payable  in  the 
subsequent  period.  If  wages  are  on  hand  unclaimed,  their 
amount  should  be  shown  as  "Amounts  Payable,"  "Wages  Pay- 
able," or  "Unclaimed  Wages." 

Taxes  accrued  represent  taxes  accrued  to  date  but  not  yet  pay- 
able; if  any  are  due  and  unpaid,  such  amount  may  be  shown 
separately  as  "Taxes  Payable,"  or  be  included  with  "Accounts 
Payable."  Provision  sliould  be  made  for  Federal  income  taxes 
under  the  heading  of  "Taxes  Accrued,"  rather  than  allocating 
them  elsewhere.  If  all  accruals  relating  to  taxes  have  pot  been 
provided  for,  a  footnote  should  indicate  such  fact.  "Taxes  Paid 
in  Advance,"  as  an  asset,  should  not  be  deducted  from  the  liabil- 
ity of  taxes  accrued. 

Interest  accrued  may  be  shown  in  total  or  separately  (as 
Interest  Accrued  on  Bonds  and  Interest  Accrued  on  Notes  Pay- 
able). Any  interest  that  has  matured  but  remains  unpaid  should 
be  stated  separately.  Interest  paid  in  advance  (as  on  notes 
discounted)  should  not  be  deducted  from  the  interest  accrued. 

Funded  Debt. — ^Bonds,  notes,  or  mortgages  maturing  in  less 
than  a  year  should  be  considered  as  current  liabilities^;  and 
the  same  would  be  true  of  long-term  securities  which  have  ma- 
tured but  are  unpaid  or  which  will  mature  in  a  day  or  two. 
All  items  should  be  described  fully,  and  the  exact  date  or  year 
of  maturity  should  be  set  out  carefully.  Securities  held  in  the 
treasury  and  in  sinking  funds  would  be  deducted  from  the  liabil- 
ities provided  their  .book  value  is  the  same  as  their  par  value; 
if  not,  such  deduction  cannot  be  made  and  such  securities  would 
be  carried  as  assets. 

Deferred  Credits. — This  group  of  items  represents  just  the 
opposite  of  deferred  charges, — all  receipts  of  income  not  yet 
earned,  and  receipts  whose  disposition  has  not  yet  been  decided. 


BALANCE  SHEET:  PROFIT  AND  LOSS  STATEMENT      315 

Advance  collections  on  sales,  unredeemed  coupons,  etc.,  are  cur- 
rent liabilities  in  toto,  not  to  be  hereunder  included. 

Reserves.— Reserves  for  depreciation  either  may  be  deducted 
from  the  corresponding  property  item,  or  be  included  among 
the  liabilities,  the  former  method  being  preferable  to  the  latter. 
In  either  event,  as  much  detail  as  possible  should  be  presented 
with  reference  thereto,  rather  than  show  in  one  lump  sum. 

Reserves  for  bad  debts,  doubtful  or  uncollectible  accounts  pre- 
ferably are  deducted  from  the  corresponding  asset  item  or  items, 
although  conditions  may  permit  of  otherwise  handling  them. 

Reserves  for  sinking  funds  are  shown  properly  under  the  head- 
ing of  "Surplus,"  representing  appropriated  surplus.  A  reserve 
for  contingencies  should  represent  what  the  title  suggests.  A 
contingency  being  unknown,  the  reserve,  therefore,  has  no  rela- 
tion to  any  known  charge  even  of  an  undetermined  amount. 

Capital  Stock.— Each  class  of  capital  stock  should  be  shown 
separately  upon  the  Balance  Sheet  at  all  times.  Relative  to 
each  class  full  information  should  be  shown  as  to  number  of 
shares  authorized,  issued,  and  outstanding,  plus  par  value,  if 
any.  The  fact  that  preferred  stock  is  cumulative  or  non-cumu- 
lative should  be  indicated,  as  well  as  the  dividend  rate.  Sub- 
scriptions to  capital  stock  should  be  included  under  the  head 
of  Capital  Stock,  and  the  uncollected  balance  on  subscriptions 
should  be  carried  as  an  asset. 

Stock  of  no  par  value  should  be  set  out  as  such,  its  carry- 
mg  value  being  the  consideration  received  therefor. 

Surplus.— This  term  in  its  usual  meaning  represents  earned 
surplus  m  contradistinction  to  capital  or  special  surplus  The 
latter  term  refers  to  paid  in  capital  in  excess  of  the  stated 
value  of  the  capital  stock,  perhaps  to  donated  capital,  apprecia- 
tion of  intangible  values,  and  appreciation  of  properties.  Again 
the  term  may  be  considered  as  indicating  surplus  available  for 
distribution  and  held  free  from  being  used  for  any  other  purpose- 
care  should  be  observed  to  prevent  one  from  assuming  this  is 
the  kind  of  surplus  referred  to  unless  such  actually  is  the  case. 

Although  it  cannot  be  considered  improper  to  show  a  deficit 
on  the  asset  side  of  the  Balance  Sheet,  if  a  capital  surplus  exists 
an  operating  deficit  should  be  deducted  therefrom     Some  ac ' 


316 


ADVANCED  ACCOUNTING 


countants  will  deduct  a  deficit  from  the  capital  stock  to  show 
actual  net  worth;  this  does  not  seem  advisable. 

Contingent  Assets  and  Liabilities.~Contingent  liabilities 
are  of  two  types: 

1.  Those  which  are  offset  by  corresponding  contingent  assets: 

a.  Liabilities  on  account  of  notes  and  drafts  discounted. 

b.  Accommodation  indorsements. 

c.  Guarantees. 

d.  Unused  letters  of  credit. 

2.  Those  which  are  not  offset  by  corresponding  contingent 
assets : 

a.  Continuing  guarantees  of  product. 

b.  Legal  or  other  claims. 

Whenever  a  contingent  liability  is  of  a  considerable  amount, 
the  Balance  Sheet  must  disclose  it: 

1.  As  a  footnote,  or 

2.  Included  in  the  body  of  the  statement.  Here  the  liability 
would  be  shown  on  the  right  side  and  the  offsetting  assets 
on  the  left  side,  the  amounts  thereof  being  included  in  the 
statement  totals. 

Capital  Versus  Revenue.— Some  of  the  basic  distinctions 
concemmg  capital  and  revenue  are  understood  by  the  student 
already.  However,  herein,  the  subject  will  be  considered,  so 
far  as  possible,  with  reference  to  corporations.  The  successful 
operation  of  a  corporation,  whether  viewed  from  the  angle  of 
an  investor,  an  executive,  or  an  accountant,  depends  upon  certain 
prmciples  of  capitalization  and  operation.  And  one  of  the  most 
important  of  these  principles  concerns  the  distinction  to  be  made 
between  transactions  which  have  to  do  with  the  permanent 
plant,-or  the  capital  transactions,-and  those  which  relate  to 
values  which  are  continually  in  a  state  of  change  because  of 
current  operations,— or  the  revenue  transactions. 

The  transactions  concerned  with  the  operation  activity  of  a 
corporation,  regardless  of  what  they  may  be,  are  separable  into 
two  distinct  groups: 

1.  Capital  transactions.  These  relate  to  the  acquisition  and 
maintenance  of  the  permanent  plant  or  equipment  with 
which  the  corporation  operates.  There  is  a  fundamental 
simihanty  here  with  that  portion  of  the  entire  asset  fund 


BALANCE  SHEET:  PROFIT  AND  LOSS  STATEMENT      317 

designated  as  the  capital  assets,  those  available  for  the  pur- 
chase of  the  permanent  plant  and  other  equipment. 
2.  Revenue  transactions.  These  relate  to  the  current  opera- 
tions, the  values  in  which  the  corporation  operates.  There 
is  a  fundamental  similiarity  here  with  that  portion  of  the 
entire  asset  fund  designated  as  the  current  assets,  those 
available  for  financing  the  current  operations  or  turnover 
of  the  business. 

Capital  assets  arise  because  cash  or  some  other  liquid  asset 
IS  converted  into  the  permanent  assets  needed  by  a  corporation. 
The  entire  cost  to  a  manufacturing  corporation  of  acquiring  land 
erecting  thereon  a  plant  suitable  to  its  needs,  and  equipping  same] 
IS  a  capital  charge  properly  carried  in  the  accounts  as  a  capital 
asset;  the  same  would  be  true  for  a  trading  corporation  which 
purchases  a  piece  of  land  and  erects  and  equips  a  building 
thereon  suitable  to  its  purposes.  In  each  instance,  a  new  asset 
IS  acquired  which  is  part  of  the  permanent  property  to  be  used 
for  the  purpose  of  conducting  the  current  operations  for  which 
the  corporation  was  created. 

Again,  any  expenditure  which  results  either  in  acquiring  an 
addition  to,  or  an  improvement  of,  the  permanent  plant  of  a 
corporation  may  be  capitalized.  The  cost  of  all  additional  land 
secured  for  building  purposes  should  be  considered  a  capital 
asset;  incidental  costs  relating  to  the  purchase  of  the  land -as 
title  investigation  fees,  survey  fees,  real  estate  agents'  commis- 
sions, etc.,  are  a  necessary  part  of  the  purchase  cost  that  should 
be  capitahzed  even  though  not  part  of  the  initial  property  pur- 
chase  cost.  The  same  would  be  true  of  the  direct  costs  of  build- 
ings and  costs  incidental  thereto  relative  to  architect's  plans 
supervision  of  construction,  etc.  Likewise,  anything  acquired 
to  provide  the  facilities  necessary  for  transacting  business  as 
machinery,  tools,  fixtures,  furniture,  etc.,  are  capital  assets  to 
be  carried  on  the  books  at  cost,  such  cost  to  be  reduced  by  valua- 
tion account  increases  periodically  by  virtue  of  depreciation. 

However,  the  capitalization  of  asset  values  may  not  always  be 
tL'^Sjl^^'^'"'^''^^^''  ^'  ^^'  ^^^^  might  suggest;  consider 

1.  A  machine  is  purchased  at  a  cost  of  $300.00,  whereas,  nor- 


318 


ADVANCED  ACCOUNTING 


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mally,  its  cost  is  $500.00.    At  what  value  should  this  asset 
be  booked?    If  it  be  booked  at  the  normal  cost,  a  credit 
results  which  some  consider  as  representing  a  profit.    How- 
ever, since  such  a  handling  creates  merely  a  paper  profit, 
if  profit  is  what  it  is  considered,  which  has  no  relation  what- 
ever to  operation,  the  correct  practice  is  to  capitalize  merely 
the  actual  cost.    As  a  matter  of  fact,  the  opinion  is  ven- 
tured that  no  profit  strictly  has  occurred,  but  merely  a  sav- 
ing, and  this,  naturally,  should  find  no  expression  upon 
the  books. 
2.  One  capital  asset  is  replaced  by  another  which  performs 
the  same  service  but  which,  because  of  certain  existing  con- 
ditions, as  quality,  quantity,  etc.,  costs  considerably  more. 
Thus,  a  small  typewriter  costing  $50.00,  may  be  replaced 
by  one  costing  $105.00,  or  a  wooden  pipe  line  may  be  re- 
placed by  a  concrete  or  steel  pipe  line.    The  old  value  dis- 
carded properly  represents  a  charge  against  income,  where- 
as, the  new  value  represents  an  addition  to  the  capital 
plant;  the  result  here  is  that  the  additional  value  repre- 
sented by  the  difference  between  the  cost  of  the  old  asset 
and  the  cost  of  the  new  one  measures  the  net  increase  in 
the  capital  plant  existing  after  the  transaction  compared 
with  what  such  capital  plant  value  was  previous  to  the 
transaction. 
All  capital  assets,  except  land,  quite  generally  depreciate  for 
one  reason  or  another  and,  since  this  shrinkage  in  value  is  some- 
thing which  always  accompanies  the  acquisition  and  use  of  capi- 
tal assets  for  current  operating  purposes,  such  shrinkage  becomes 
a  proper  charge  against  the  income  secured  from  such  current 
operations.    The  subject  of  depreciation  is  not  here  considered. 
Finally,  as  to  the  capital  assets,  no  recognition  should  be  given 
to  fluctuations  in  market  price,  because  no  particular  effect  oc- 
curs therefrom  against  the  corporation  holding  them,  so  long  as 
they  are  used  for  the  purpose  acquired,  and  so  long  as  they 
are  maintained   in  their  original  condition.     In  other  words, 
no  profit  thereon  should  be  recognized  unless  actually  realised, 
and  all  losses  which  might  occur  due  to  the  final  discarding  of 
a  capital  asset  should  be  provided  against  in  advance  by  charges 
against  earnings. 


BALANCE  SHEET:  PROFIT  AND  LOSS  STATEMENT      319 

Revenue  transactions  relate  to  a  corporation's  activity  in  con- 
nection with  acquiring,  converting,  and  realizing  upon  the  cur- 
rent assets,  and  also  in  connection  with  all  the  incidental  opera- 
tion elements  which  may  arise  thereunder.  In  other  words,  even 
though  they  deal  with  real  elements  in  the  form  of  current  assets, 
they  include  all  operating  or  trading  activities  considered  to  be 
of  a  profit  and  loss  nature.  The  assets  acquired  as  a  result 
of  revenue  transactions  are  not  held  for  the  permanent  uses  of  a 
corporation,  but  only  to  be  realized  upon  at  a  profit. 

Revenue  transactions  cover  many  things  other  than  the  secure- 
ment  of  tangible  asset  values.  Labor  must  be  paid  for,  and 
consumable  supplies  and  incidental  services  must  be  secured. 
A  manufacturing  corporation  purchases  raw  materials.  These 
are  worked  upon  in  the  various  stages  of  the  manufacturing 
processes  with  the  result  that  as  progress  is  made  toward  the 
finished  articles,  labor  and  supphes  are  consumed  in  connection 
therewith.  When  the  completed  product  emerges,  it  represents 
a  composite  of  material,  labor,  and  supplies  and,  when  sold,  for 
either  cash  or  credit,  it  is  presumed  that  value  comes  back  in  an 
amount  sufiicient  to  reimburse  the  corporation  for  all  expendi- 
tures made  plus  a  profit.  It  is  net  profit  which  is  presumed  to 
compensate  the  corporate  entity  for  the  use  of  both  capital  and 
current  assets.  The  capital  assets  are  not  held  for  profit  pur- 
poses; if  profits  are  realized  directly  therefrom,  it  is  a  mere  in- 
cidental matter  representing  the  occasional  disposal  of  a  capital 
asset  at  a  profit. 

Statement  of  Profit  and  Loss  Title.-It  was  stated  above 
that  one  of  the  objects  of  keeping  a  set  of  books  accurately 
upon  sound  accounting  principles  for  a  business  enterprise  is 
to  permit  its  actual  financial  condition  to  be  ascertained  at  any 
time.  Such  a  condition  is  evidenced  by  the  Balance  Sheet  which 
for  a  corporate  enterprise,  has  been  discussed  in  more  or  less 
detail  m  the  first  portion  of  the  present  chapter.  The  second 
object  of  keeping  a  set  of  books  accurately  upon  sound  account- 
ing principles  for  a  business  concern  is  to  permit  its  operations 
to  be  so  summarized  that  an  intelligent  presentation  may  be 
made  of  the  causes  responsible  for  the  creation  of  fhe  net  worth 
or  insolvency  as  displayed  by  the  Balance  Sheet,  or  the  increase 
or  decrease  therein  over  its  amount  as  of  a  prior  date     Such 


320 


ADVANCED  ACCOUNTING 


summarization  is  evidenced  by  the  Statement  of  Profit  and  Loss 
which,  for  a  corporate  enterprise,  particularly,  will  be  dis- 
cussed in  more  or  less  detail  in  the  remaining  portion  of  the 
present  chapter. 

Various  titles  are  used  to  designate  a  statement  of  operations, 
the  correct  one  to  be  used  under  any  given  set  of  conditions 
depending  more  or  less  upon  the  content  of  such  a  statement. 
The  following  are  illustrative: 

1.  Statement  of  Income  and  Profit  and  Loss.  This  title  appro- 
priately applies  to  a  statement  for  either  a  trading  or  a 
manufacturing  enterprise  in  which  are  included  all  the 
operations,  plus  surplus  changes. 

2.  Summary  of  Income  and  Profit  and  Loss.  This  title  is 
proper  for  a  summary  form  No.  1,  above,  in  which  are 
shown  only  major  group  totals. 

3.  Statement  of  Income  and  Capital  Account.  This  title  is 
proper  for  a  sole  trader  or  partnership  concern;  it  shows, 
in  addition  to  income,  a  summary  of  the  capital  account  or 
accounts. 

4.  Statement  of  Profits  and  Income.  This  title  is  used  in  an 
earlier  production  by  the  writer  for  the  purpose  of  specif- 
ically assisting  the  more  elementary  student  to  comprehend 
and  remember  the  results  to  be  secured  by  a  logical  group- 
ing of  items  as  concerns  what  has  taken  place  during  an 
elapsed  period  of  time;  further,  theoretically,  this  title 
seems  more  accurate  in  its  meaning  than  any  other.  How- 
ever, since  general  practice  does  not  recognize  this  title  to 
any  considerable  extent,  nothing  more  will  be  said  thereon 
in  the  present  volume. 

5.  Statement  of  Income.  When  a  statement  ends  with  set- 
ting out  the  net  income,  this  title  appears  fairly  accurate. 

6.  Statement  of  Profit  and  Loss.  This  is  a  general  title  which, 
among  accountants,  is  assumed  to  be  appropriate  under 
perhaps  all  the  conditions  where  any  other  title  above  indi- 
cated could  be  used. 

7.  Statement  of  Revenue  and  Expenses.  This  title  is  usable 
in  connection  with  all  enterprises  not  commercial. 

8.  Etc.,  as  desired. 


BALANCE  SHEET:  PROFIT  AND  LOSS  STATEMENT     321 

Since  all  these  statements  cover  an  elapsed  period  of  time,  the 
title  should  indicate  such  fact,  as: 

!•  Statement  of  Profit  and  Loss 

Year  Ended  December  31,  1921 

2.  Statement  of  Profit  and  Loss 

January  1,  1921,  to  December  31,  1921 

Further,  just  as  the  Balance  Sheet  is  an  estimate  of  value 
only,— an  expression  of  one's  opinion  thereon,— the  balance  of 
the  undistributed  profits  or  losses  must  be  considered  only  as  an 
estimate. 

Arrangement  of  Statement  of  Profit  and  Loss  Items.— As 
stated  in  connection  with  the  Balance  Sheet,  every  statement 
should  be  prepared  from  the  viewpoint  of  the  layman  readily 
understanding  it.  And  in  this  connection,  to  a  far  greater  extent 
than  with  the  Balance  Sheet,  the  running  or  report  form  of 
Statement  of  Profit  and  Loss  presents  a  clearer  idea  of  what  has 
taken  place  than  does  the  account  form.  In  fact,  most  account- 
ants of  repute  have  adopted  the  running  form  for  the  Statement 
of  Profit  and  Loss  exclusively;  therefore,  none  other  need  be 
considered. 

The  general  outline  form  for  any  Statement  of  Profit  and 
Loss  is  practically  the  same,  but  a  great  variation  exists  in  the 
allocation  thereon  of  specific  items.  Such  variation  as  to  the 
position  of  detail  items  depends  upon  two  primary  elements: 

1.  The  theoretical  training  and  ideas  of  the  particular  account- 
ant who  prepares  the  statement.  Many  accounting  theories 
still  are  debatable,  and  any  one  accountant  should  not 
presume  that  his  method  of  treatment  is  the  only  correct 
one;  it  may  be  for  him  but,  in  the  mind  of  another  who  is 
at  least  his  equal  in  intelligence,  if  not  his  superior  therein 
the  former's  treatment  may  be  considered  in  error. 

2.  The  case  in  hand  may  require  a  treatment  of  certain  items 
m  a  way  other  than  the  usual  one  followed.  The  members 
of  a  certain  association  of  manufacturers,  for  example  may 
be  agreed  upon  a  uniform  way  of  handling  cash  discounts 
on  purchases.  It  would  not  be  well  for  an  accountant  pre- 
paring  a  Statement  of  Profit  and  Loss  for  the  business  of 
a  member  of  this  association  to  depart  from  the  accepted 
practice  therein.     Pure  theorists  always  take  issue  with 


322 


ADVANCED  ACCOUNTING 


ii 


I 


t 


what  they  find;  the  practical  accountant  will  govern  him- 
self primarily  by  the  conditions  encountered.     Unless  the 
issue  be  of  major  import,  the  latter  will  be  loathe  to  tear 
down  an  accepted  practice,  because,  by   so  doing,  com- 
parative statistics  may  be  knocked  away  and  prove  useless. 
Again,  expediency  may  dictate  that  it  is  impossible  to  pro- 
duce from  the  accounts  as  found  a  Statement  of  Profit  and 
Loss  in  as  intelligent  a  form  as  might  be  desired. 
A  basic  arrangement  for  a  Statement  of  Profit  and  Loss,  in 
running  form,  for  either  a  trading  or  a  manufacturing  corpora- 
tion, conforming  practically  to  the  arrangement  suggested  previ- 
ously in  an  earlier  volume,  would  be  about  as  follows: 


Gross  Sales 
Deductions  from  Sales 
Net  Sales 

Cost  of  Goods  Sold 
Gross  Profit  on  Sales 
Selling  Expenses 
Selling  Profit 
General  Expenses 
Profit  from  Operations 


Additional  Income 

Gross  Income 

Deductions  from  Income 

Net  Income 

Surplus  Beginning  of  Period 

Profit  and  Loss  Credits 

Gross  Surplus 

Profit  and  Loss  Debits 

Surplus  End  of  Period 


This  arrangement  is  such  that  the  surplus  at  the  end  of  the 
period  as  shown  will  support  the  item  of  Surplus  at  the  end  of 
the  period  as  found  upon  the  Balance  Sheet. 

Gross  Sales.— This  represents  the  gross  business  done  during 
the  reviewed  period.  In  concerns  other  than  the  usual  type 
of  trading  and  manufacturing,  the  title  of  Gross  Sales,  to  repre- 
sent the  gross  business  done  during  a  certain  period  of  time, 
seems  in  error;  for  example: 

1.  Professional  practice.  Since  goods  are  not  sold,  only 
charges  being  made  for  services  rendered,  the  caption  repre- 
senting gross  business  might  better  be  Gross  Earnings  or 
Gross  Revenue. 

2.  Business  related  to  approval  shipments.  Gross  charges 
against  customers  are  designated  correctly  as  Shipments 
Billed. 

3.  Business  related  to  contract  work.  Hereunder,  one  should 
distinguish  between  contracts  completed  and  uncompleted 
contracts : 

a.  Completed  contracts.     Billings  representing   completed 


f 


BALANCE  SHEET:  PROFIT  AND  LOSS  STATEMENT      323 

work  only  may  be  designated  as  Completed  Contracts 
Billed. 

b.  Uncompleted  contracts.    Billings  representing  completed 

portions  of  contracts  not  yet  fully  completed  may  be 

designated  as  Bills  Rendered. 

Only  in  trading  and  in  manufacturing  concerns  does  the  title 

of  Gross  Sales,  representing  gross  business,  appear  to  be  in  order. 

Hereunder,  the  item  would  be  composed  of: 

1.  Charges  to  customers,  or 

2.  Cash  sales,  or 

3.  Both  charges  to  customers  and  cash  sales. 

Whenever  a  customer  is  billed  in  error,  and  this  error  later 
is  corrected,  the  correction  made  should  be  reflected  in  the  gross 
sales  item. 

Sales  may  be  shown  either  in  one  lump  total,  or  be  set  out  by 
classes  of  goods  or  by  departments.  Departmental  transfers  are 
not  sales  to  be  reflected  upon  the  Profit  and  Loss  Statement. 

Deductions  from  Sales.— In  general,  these  deductions  are 
of  two  kinds,  or  classes: 

1.  Usual: 

a.  Returns. 

b.  Allowances. 

c.  Freight  and  express  outward. 

2.  Unusual: 

a.  Trade  discounts.  Included  herein  would  be  discounts 
granted  a  customer  after  he  has  purchased  a  specified 
quantity.  A  cash  discount,  the  terms  of  which  are  such 
that  if  settlement  is  not  made  within  a  specified  time, 
the  discount  will  be  given  but  interest  will  be  charged,' 
is  a  trade  discount. 

b.  Delivery  charges.  This  deduction  would  occur  where 
goods  are  sold  delivered  at  a  uniform  price. 

c.  Revenue  or  excise  taxes.  This  is  a  deduction  only  when 
amount  is  based  upon  sales. 

d.  Commissions.  This  is  a  most  unusual  deduction,  but 
may  be  found  in  some  classes  of  business. 

Net  Sales  -As  ordinarily  understood,  this  item'needs  no  com- 
ment If  the  deductions  from  sales  be  small  in  amount,  the 
first  Item  set  out  in  the  statement  may  be  net  sales.    If  the  busi- 


il 


324 


ADVANCED  ACCOUNTING 


ness  is  one  involving  goods  sent  out  upon  approval,  so  that  gross 
charges  are  designated  against  customers  as  Shipments  Billed, 
the  net  sales  item  probably  will  be  called  only  Sales. 

Cost  of  Goods  Sold ;  Cost  of  Manufacture  and  of  Manufac- 
tured Product  Sold.— The  items  to  be  used  in  compilmg  the 
section  of  the  revenue  statement  captioned  Cost  of  Goods  Sold 
depend,  basically,  upon  whether  the  concern  is  a  trading  or  a 
manufacturing  enterprise: 

1.  Trading  enterprise: 


a.  Usual  set-out: 

Inventory,  January  1,  19 — , 

Purchases,  g  a 

Freight  and  Cartage  Inward,  |  ^ 

Cost  of  Goods  Handled, 

Inventory,  December  31,  19—, 

Cost  of  Goods  Sold, 

b.  Unusual  set-out: 

Purchases  (plus  freight  and  cartage  inward). 
Add:  Decrease  in  Inventory  (or  Deduct:  In- 
crease  in  Inventory), 

Cost  of  Goods  Sold, 


%  i 


In  a  departmentalized  business,  the  cost  of  goods  sold  may  be 
set  out  for  each  department,  as  where  the  sales  have  been  thus 
stated,  provided  the  person  for  whom  the  statement  is  prepared 
wishes  such  a  handling,  or  it  is  deemed  desirable  by  the 
accountant. 

2.  Manufacturing  enterprise.  One  cannot  be  dogmatic  as  to 
what,  constitutes  the  cost  of  goods  sold  in  a  manufacturing 
establishment,  since  accountants  differ  widely  in  their  views 
upon  the  subject  and  these  varying  views  must  be  given 
weight  and  serious  consideration,  especially  under  certain 
conditions.  In  general,  this  difference  of  opinion  is  based 
upon  what  a  particular  accountant  wishes  to  have  con- 
sidered as  elements  of  valuation  as  relates  to  the  inventory 
of  manufactured  product.  However,  a  typical  outline  of 
the  items  composing  the  cost  of  manufactured  product  sold 
would  be  about  as  below;  in  any  particular  case,  the 
amount  of  detail  shown  upon  the  statement  depends  upon 
either  the  chart  of  accounts  used  or  the  analysis  made  of 


BALANCE  SHEET:  PROFIT  AND  LOSS  STATEMENT     325 

the  accounts  actually  in  use.  Likewise,  it  is  customary  in 
a  manufacturing  concern,  at  least,  to  prepare  a  separate 
statement  showing  the  cost  of  goods  sold,  and  carry  into 
the  Statement  of  Profit  and  Loss  only  the  final  figure 
thereon  secured.  Such  a  statement  is  titled  Statement 
Showing  Cost  of  Manufacture  and  Cost  of  Manufactured 
Product  Sold.  It  was  mentioned  in  the  beginning  portion 
of  the  present  chapter  as  Exhibit  C. 


Cost  of  Manufacture: 


Unfinished  Product,  Inventory,  January  1,  19 — , 

Raw  Material: 

Inventory,  January  1,  19 — , 

Purchases,  | 

Freight  and  Cartage  In,  $ 

Marine  Insurance,  j 

Purchase  Department: 

Salaries  and  Wages,  $  ^ 

Supplies  and  Expenses,  $  ^ 


Deduct:  Inventory,  December  31,  19 — , 
Direct  Labor, 
Manufacturing  Expenses: 

Superintendent  and  Foremen  Salaries, 
Factory  OflSce: 
Salaries  and  Wages, 
Supplies  and  Expenses, 

Receiving  Department: 
Wages, 
Supplies  and  Expenses, 

Stores  Department: 
Wages, 
Supplies  and  Expenses, 

Stock  Department: 

Wages, 

Supplies  and  Expenses^ 
Royalties  Paid, 

Janitors,  Watchmen,  Elevator  Operators, 
Heat,  Light  and  Power: 

Wages, 

Fuel, 

Oil,  Waste,  etc., 

Current, 


i 
i 


%  i 

%  i 


% 


i 


%  i 


%  i 

%  i 


%  i 


«  i 


$  i 

s  i 


$  i 


S  i 


:| 


326  ADVANCED  ACCOUNTING 

Repairs: 

Buildings,  |  ^ 

Machinery  and  Equipment,  I  ^ 

Insurance — Fire,  Liability,  etc.  (factory), 

Taxes — Property  (factory), 

Unemployed  Time, 

Inspection, 

Defective  Goods, 

Experimental  Expenses, 

Infirmary, 

Sundries, 
Depreciation: 

Buildings,  |  ^ 

Machinery  and  Equipment,  $  i 

Patents,  j  j 

Deduct:   Scrap  Sales, 

Deduct:   Unfinished  Product  Inventory,  Decem- 
ber 31,  19—, 

Cost  of  Manufacture, 

Add:  Manufactured  Product,  January  1,  19 — , 

Deduct:  Manufactured  Product,  December  31,  19 — , 
Cost    of    Manufactured    Product    Sold,    January    1, 
19 — ,  to  December  31,  19 — , 


$ 


$ 
$ 

$ 
$ 
$ 


%  i 


%J 
%  i 

t  i 
U 


In  an  actual  case,  it  is  probable  that,  where  the  amount  of  de- 
tail to  be  shown  upon  the  statement  is  as  much  as  is  set  out 
above,  certain  groups  thereof  would  be  shown  in  total  and  the 
detail  items  of  each  such  group  would  be  presented  in  the  form 
of  a  separate  schedule. 

Gross  Profit  on  Sales. — ^No  comment  appears  necessary  be- 
yond the  fact  that  for  a  manufacturing  company  this  item  may 
be  called  Manufacturing  Profit. 

Selling  Expenses. — The  items  under  this  caption  would  be 
about  as  follows:  • 

Salaries  of  Sales  Manager  and  Clerks. 

Salaries  of  Salesmen. 

Conunissions  of  Salesmen. 

Traveling  Expenses  of  Salesmen. 

Advertising. 

Catalogues. 

Customers '  Entertainment. 


BALANCE  SHEET:  PROFIT  AND  LOSS  STATEMENT      327 


Rent  of  Sales  OflSces. 
Postage  and  Stationery. 
Telephone  and  Telegraph. 
Sundry  Sales  OflSce  Expenses. 

Selling  Profit. — No  comment  appears  necessary. 

General  Expenses. — These  expenses  are  assumed  to  apply  to 
the  business  as  a  whole,  and  frequently  are  designated  as  Ad- 
ministrative and  General  Expenses.  The  items  under  this  cap- 
tion would  be  about  as  follows: 

Salaries  of  Officers. 

Salaries  of  General  Office  Clerks. 

Rent  of  General  Office. 

Postage,  Stationery,  and  Printing. 

Telephone  and  Telegraph. 

Legal  Services. 

Public  Accountants'  Services. 

Directors'  Fees. 

Traveling  Expenses  of  Officers  and  General  Office  Clerks. 

Corporation  and  Capital  Stock  Taxes. 

Exchange  and  Collection  Charges. 

Dues  and  Subscriptions. 

Contributions  and  Donations. 

Sundry  Office  Expenses. 

Selling  and  general  expenses  frequently  are  combined  under 
one  heading  as  where  the  items  are  relatively  few  in  number  or 
where  the  expense  classification  is  more  or  less  indefinite  as  to 
accuracy.  If  done,  there  will  result  no  item  of  selling  profit. 
However,  for  statistical  purposes,  at  least,  separate  if  possible. 

Profit  from  Operations. — The  profit  secured  from  the 
regular  operations  of  the  business  is  represented  by  the  above 
title.  Numerous  other  captions  or  titles  for  this  item  are  in  use, 
but  the  above  is  deemed  all-sufficient. 

Additional  Income. — The  items  hereunder  included  represent 
extraneous  income  secured  from  sources  other  than  regular  oper- 
ations.   An  illustrative  list  would  be  as  follows: 

Cash  Discounts  on  Purchases. 

Interest  on  Bonds  Owned. 

Interest  on  Notes  and  Accounts  Receivable. 

Interest  on  Bank  Balances. 

Dividends  on  Stocks  Owned.  , 

Net  Income  from  Real  Estate. 

Profit  from  Sale  of  Temporary  Investments. 

Profit  from  Foreign  Exchange. 

Royalties  Received. 


328 


ADVANCED  ACCOUNTING 


I 


Commissions  Received. 

Profit  from  Sale  of  Material,  etc. 

Sundries. 

The  only  item  requiring  comment  seems  to  be  Net  Income 
from  Real  Estate.  The  real  estate  here  included  may  represent 
either  investment  real  estate  or  real  estate  held  for  operation 
purposes  although  not  part  of  the  plant  operating  unit.  A  manu- 
facturing company  or  a  mining  company  may  own  houses  which 
are  maintained  to  house  the  employees.  The  net  income  there- 
from is  treated  in  two  different  ways  depending  upon  the  attitude 
of  the  accountant: 

1.  As  additional  income.  Here  it  must  be  assumed  that  such 
tenement  investments  are  a  mere  collateral  matter  to  pro- 
duce additional  income. 

2.  As  a  manufacturing  element.  Here  it  must  be  assumed  that 
the  housing  of  workmen  is  a  manufacturing  expense. 

The  decision  of  the  question  for  any  particular  case  would 
seem  to  hinge  upon  the  exact  facts  involved  and  upon  notliing 
else.  If  the  housing  activity  is  necessary  primarily  either  to  re- 
duce labor  turnover  or  to  improve  working  conditions,  then  the 
logical  conclusion  would  be  to  consider  operating  the  housing 
property  as  a  manufacturing  element.  It  would  be  usual  to  show 
the  details  relative  to  the  item,  as  total  rentals  and  total  operat- 
ing expenses  in  detail.  Although  it  would  seem  that  income 
from  property  not  held  for  investment,  but  for  operation  pur- 
poses relative  to  housing,  may  be  handled  in  either  way  shown 
above,  if  the  net  result  shows  a  loss  thereon,  the  second  method 
of  handling  seems  preferable  to  the  first  one. 

Gross  Income. — ^This  item  requires  no  comment. 

Deductions  from  Income. — These  items  represent  the  cost 
of  securing  capital  and  losses  chargeable  against  the  current 
period's  income  as,  for  example: 

Cash  Discounts  on  Sales. 

Interest  on  Bonds  Payable. 

Interest  on  Notes  and  Accounts  Payable. 

Bad  Notes  and  Accounts. 

Amortization  of  Bond  Discount  and  Expense. 

Loss  from  Sale  of  Temporary*Investments. 

Loss  from  Foreign  Exchange. 

Net  Loss  from  Real  Estate. 

Income  Taxes. 

Sundries. 


BALANCE  SHEET:  PROFIT  AND  LOSS  STATEMENT      329 

Net  Income  and   Surplus  at   Beginning  of   Period.— No 

comment  seems  necessary. 

Profit  and  Loss  Credits.— This  group  of  items  would  cover 
the  following: 

Extraordinary  profits  from  the  sale  or  other  disposal  of  the  fixed  and 

capital  assets. 
Discounts  on  the  redemption  of  capital  stock. 
Items  applicable  to   a  prior  period's  operations  representing  surplus 

credit  adjustments. 

Gross  Surplus. — No  comment  seems  necessary. 
Profit   and   Loss   Debits.— These  items  represent  the   con- 
verse of  those  shown  above  under  Profit  and  Loss  Credits,  as: 

Extraordinary  losses  from  the  sale  or  other  disposal  of  the  fixed  and 

capital  assets. 
Premiums  on  the  redemption  of  capital  stock. 

Items  apphcable  to  a  prior  period's  operations  representing  surplus 
debit  adjustments. 

Surplus  at  End  of  Period. — No  comment  is  here  necessary 
beyond  the  fact  that  this  item  should  agree  with  the  surplus 
shown  upon  the  Balance  Sheet  prepared  as  of  the  end  of  the 
period  covering  which  the  Profit  and  Loss  Statement  has  been 
drawn. 

Comparative  Statements ;  Statement  Statistics.— The  basic 
form  of  the  statements  above  outlined  may  be  deviated  from 
whenever  desirable ;  it  is  only  suggestive  at  best.  Comparative 
statements  are  highly  desirable  at  times  especially  where,  from 
one  year  to  the  next,  no  radical  change  has  occurred  in  the  char- 
acter of  the  business  or  in  the  chart  of  accounts.  Space  in  the 
present  chapter  does  not  permit  of  any  discussion  of  such  state- 
ments herein  (See,  post:  Chap.  10). 

In  the  preparation  of  statements,  statistics  often  are  included, 
as  to  averages  per  unit  produced,  averages  per  unit  sold,  and  the 
ratio  of  cost,  expenses,  and  profit  to  sales.  These  statistics  are 
of  considerable  interpretative  value  to  an  executive.  Space  does 
not  permit  of  a  discussion  of  statistics  in  this  volume ;  the  reader 
is  referred  to  the  various  books  thereon  now  published. 

Illustrative  Problem  and  Solution 

ProUem.~The  foUowing  is  a  Trial  Balance  of  the  General  Ledger,  as  at 
December  31,  1920,  of  the  Jones  Manufacturing  Corporation  of  New 
York  City,  which  is  a  manufacturer  of  heavy  machinery.     Entries  for 


I 


.  I 


I 


i 


330 


ADVANCED  ACCOUNTING 


unexpired  insurance,  interest  paid  in  advance,  and  depreciation  charges 
have  been  made,  the  amounts  therefor  ai)pearing  in  the  Trial  Balance. 
Note  that  in  the  working  papers  submitted  as  part  of  the  solution,  the 
Furplus  item  in  the  Trial  Balance,  after  closing,  is  made  up  of  two  amounts, 
—the  surplus  at  the  beginning  of  the  year,  and  the  net  profit  for  the  year 
transferred  to  Surplus  account. 

THE  JONES  MANUFACTURING  CORPORATION 

Trial  Balance 
December  31,  1920 


(Before  Closing) 


Land, 
Buildings, 

Reserve  for  Depreciation— Buildings, 

Machinery  and  Equipment, 

Reserve  for  Depreciation — Machinery  and 

Equipt. 
Furniture  and  Fixtures, 
Patents, 
Inventories — January  1,  1920: 

Manufactured  Product, 

Unfinished  Product, 

Material, 
Notes  Receivable, 
Accounts  Receivable, 
First  National  Bank, 
Petty  Cash, 

Interest  Paid  in  Advance, 
Unexpired  Insurance, 
Bonds, 

Notes  Payable, 
Accounts  Payable, 
Capital  Stock, 
Surplus, 

Material  Purchases, 
Direct  Labor, 
Indirect  Labor, 
Shop  Supplies, 
Factory  Expense, 
Heat,  Light  and  Power, 
Freight  and  Cartage  In, 
Insurance — Factory, 
Depreciation — Buildings, 
Depreciation — Machinery  and  Equipment, 
Depreciation — Patents, 
Depreciation — Furniture  and  Fixtures, 
Taxes — Factory, 


S  218,000.00 
180,000.00 

86,000.00 


3,025.00 
188,235.00 

404,000.00 

69,476.00 

500,000.00 

175,000.00 

,525,000.00 

184,600.00 

600.00 

560.00 

250.00 


1,905,260.00 

425,250.00 

30,000.00 

101,000.00 

10,000.00 

39,000.00 

1,000.00 

15,000.00 

4,600.00 

7,500.00 

11,765.00 

275.00 

2,650.00 


%     4,500.00 


7,500.00 


250,000.00 
15,000.00 
661,995.00 
800,000.00 
907,408.00 


BALANCE  SHEET;  PROFIT  AND  LOSS  STATEMENT      331 


Advertising, 

Salesmens'  Salaries, 

Salesmens '  Traveling  Expense, 

Insurance—  Manufactured  Product, 

Freight  and  Cartage  Out, 

Miscellaneous  Selling  Expense, 

Sales, 

Return  Sales  and  Allowances, 

Officers'  Salaries, 

OflBce  Salaries, 

Stationery  and  Printing, 

Postage, 

General  Expense, 

Legal  Expense, 

Bad  Debts  Written  Off, 

Interest, 

Discount  on  Sales, 

Discount  on  Purchases, 


5,000  00 
130,000.00 

7,000.00 
450.00 
500.00 

3,000.00 

8,000.00 

70,000.00 

20,000.00 

850.00 

700.00 

1,500.00 

4,000.00 

4,000.00 

2,500.00 

95,005.00 


4,750,250.00 


43,578.00 


$7,440,231.00     $7,440,231.00 


$400,000.00 

75,000.00 

450,000.00 


Inventories,  December  31,  1920: 

Manufactured  Product, 

Unfinished  Product, 

Material  on  Hand, 
Prepare  the  following: 

Balance  Sheet — Exhibit  A. 

Profit  and  Loss  Statement — Exhibit  B. 

Statement  of  Cost  of  Manufacture  and  Cost  of  Manufactured  Product 
Sold— Exhibit  C. 
In  connection  with  the  above,  submit: 

Working  papers. 

Solution  of  Problem. — This  problem  and  solution  are  presented  to  review 
a  number  of  elements  related  to  statement  preparation  which  should  be 
well  understood  by  the  student  who  has  reached  this  portion  of  his  work 
but  perhaps  have  been  forgotten. 

Working  Papers.— Working  papers  closing  a  set  of  books  are  in  general 
use  in  a  large  business  for  the  preparation  of  the  financial  statements, 
because  they  permit  of  ascertaining  the  results  of  the  main  divisions  of 
the  operating  end  of  the  enterprise,  as  well  as  its  financial  condition,  with- 
out requiring  first  the  posting  of  adjusting  and  final  closing  entries.  The 
use  of  proper  working  papers  will  prove  the  mechanical  accuracy  of  the 
figures  throughout,  and  the  final  closing  Journal  entries  can  be  made  directly 
from  it.  In  the  present  illustration,  all  the  usual  adjustments,  other  than 
goods  inventories  are  considered  as  having  been  entered  upon  the  books. 
These  usual  adjustments  will  present  no  difiiculty,  and  have  been  omitted; 
the  method  of  booking  involved  is  merely  to  charge  and  credit  the  proper 
accounts  concerned. 

The  working  papers  presented  below  show  the  following  information: 
Trial  Balance  (before  closing). 


332 


ADVANCED  ACCOUNTING 


THE  JONES  MAN0FAC 
Working  Papbrs 


Account 

Land 

Buildings 

Reaerve  for  Depreciation — 

Buildings 
Machinery  and  Equipment 
Reserve  for  Depreciation— Ma- 
chinery and  Equipment 
Furniture  and  Fixtures 
Patents 
Inventories  January  1,  1920: 

Manufactured  Product 

Unfinished  Product 

Material 
Notes  ReceivaUe 
Accounts  Receivable 
First  National  Bank 
PfettyCash 

Interest  I^d  in  Advance 
Unexpired  Insurance 
Bonds 

Notes  Pkyable 
Accounts  Plajrable 
Capital  Stock 
Surplus 

Matoia!  Purchases 
Direct  Labor 
Indirect  Labor 
Shop  Supplies 
Factory  Expense 
Beat,  Light  and  Power 
Freight  and  Cartage  In 
Insurance — Factory 
Depreciation — Buildings 
Depreciation — Machinoy  and 

Equipment 
Depreciation — Patents 
Depreciation — ^Furniture  and 

Futures 
Taxes— Factory 
Advertising 
Saleamens' Salaries 
Salesmeos'  Travding  Expense 
Insurance— Manufactured 

IVoduct 
Frdght  and  Cartage  Out 
Miscellaneous  Selling  Expense 
fiaJeg 

Setura  Sales  and  AUowanoes 
(Carried  Forward) 


Trial  Balance 
December  31,  1920 
(Before  Closing"* 

$218,000.00 
180.000.00 


Adjustments 

and 
Inventwies 


Decembtf 


Manufa 


Aooo 


86.000.00 


3,025.00 
188.235.00 

404,000  00 

69.476.00 

500.000.00 

175.000.00 

1.525,000  00 

184.500.00 

500.00 

550.00 

250.00 


$4,500.00 


7.500.00 


(»)$404.000.00 
®  69.476.00 
©500,000.00 


250.000.00 
15.000.00 
661.995.00 
800,000.00 
907,408.00 


2.905,250.00 

425.250.00 

30,000  00 

101,000  00 

10.000.00 

39.000.00 

1.000.00 

15.000.00 

4.500.00 

7.500.00 
11.765.00 

275.00 

2.650.00 

5,000.00 

130,000.00 

7.000.00 

450.00 

500,00 

3,000.00 

8.000.00 


®$500.000.00  ®  450.000.00  $2,955,250.00 

425,250.00 

30,000  00 

101,000  00 

10,000.00 

39,000  00 

1.000.00 

15,000.00 

4,500.00 

7,500.00 
11.706.00 


2.060.00 


4,750.250.00 


$7,241,676.00  $7,396,653.00      $500,000.00  $1,423,476.00  $3.602.01ft.00 


BALANCE  SHEET:  PROFIT  AND  LOSS  STATEMENT      333 


TURING  CORPORATION 
Closinq  Books 
31.1920 


cturing 
unt 


Selling 
Account 


Profit  and  Loss 
Account 


Trial  Balance 

December  31,  1920 

(After  Closing) 

$218,000.00 
180,000  00 


86.000.00 


3.025.00 
188.235.00 


$4,500.00 


7.500.00 


175.000  00 

1.525,000.00 

184.500.00 

500  00 

550.00 

250  00 

250.000.00 

15.000  00 

661.905.00 

800.000  00 

1.747.065.00 

$275.00 


$  5.000.00 

130.000.00 

7,000.00 

450.00 

500.00 

3.000.00 

8.000.00 


$4,750,250.00 


$153,950.00  $4,750,250.00 


$275.00 


$2,561,060.00  $3,486,060.00 


334 


ADVANCED  ACCOUNTING 


THE  JONES  MANtTFAC 


WoRKINa  Papbbs 

DoMunber 

Trial  Balance 

Adjustments 

Account 

December  31,  1920 

and                             Muufa 

(Before 

Closing) 

Inventories                             Acco 

(Brought  Fwward) 

$7,241,676.00  $7,396,653.00 

$500,000  00  $1,423,476.00  $3,602,915.00 

Officers'  Salaries 

70,000.00 

Office  Salaries 

20,000.00 

Stationery  and  Printing 

850.00 

Postage 

700.00 

General  Elxpense 

1,500.00 

Legal  Expense 

4,000.00 

Bad  Debts  Written  Off 

4,000.00 

Interest 

2.500.00 

Discount  on  Sales 

95.005.00 

Discount  on  Purchases 

43.578.00 

7,440,231.00 

7.440.231.00 

Inventories— December  31, 

1920: 

Manufactured  Product 

®  400,000  00 

Unfinished  Product 

©    75,00000 

Material  on  Hand 

0  450,000  JB 

Manufacturing  Account: 

Unfinished  Product,  Inv't'y 

1/1/20 

®    69.476.00                              69.476.00 

Unfinished  Product,  Inv't'y 

12/31/20 

®    75.000  00 

Selling  Account: 

Manufactured  Product, 

Inv't'y  1/1/20 

(1)404.000  00 

Manufactured  Product, 

Inv't'y  12/31/20 

(!)  400,000.00 

$1,898,476  00  $1,898,476.00 

Cost  of  Manufactured  Product 

—To  Selling 

$3,672^1.00 

Net  Profit  on  Sales— To  Pl-ofit 

and  Lobs 

Net  Profit— To  Surplus 


Surplus  Account 

Balance,  December  31,  1920  (before  dosing),  $907,  «08.00 

Profit  for  Year  1920,  839 ,  657 .  00 

Balance,  December  31. 1920  (after  dodng),  $1.747.085.00 


BALANCE  SHEET:  PROFIT  AND  LOSS  STATEMENT      335 

TURING  CORPORA'nON 
Closing  Books 


31,1920 


cturing 


Seffing 
Account 

$153,950.00  $4,750,250.00 


Pw^fit  and  LoBB 
Account 


$     275.00 

70,000.00 

20,000.00 

850.00 

700  00 

1.500.00 

4,000.00 

4.000.00 

2,500.00 

95.005.00 


TVial  Balance 

December  31. 1920 

(After  Closing) 

$2,561,060.00  $3,486,060.00 


$43,578.00 


400,000  00 

75,000.00 

450,000.00 


75.000.00 


404.000.00 


400.000.00 


3.507.391.00    3.597,391.00 
$3,672,391  00 

994.909  00 


904,909.00 


$5.150,250.00  $5.150.250.00 


839.657.00 


$1.038.487.00  $1.038.487.00  $3.486.060.00  $3.486.060.00 


336 


ADVANCED  ACCOUNTING 


fi 


5 


$600,000.00 


$500,000.00 


$450,000.00 


$450,000.00 


Inventory  adjustments  (other  adjustments  already  have  been  made). 
Distribution  of  accounts: 

Manufacturing. 

Selling. 

Administrative  (Profit  and  Loss). 

Trial  Balance  (after  closing). 

In  connection  with  the  above,  the  following  adjusting  entries  are  re- 
quired. These  have  been  keyed  to  the  Inventory — Adjustments  columns 
on  the  working  sheets: 

(1) 

Material  Purchases, 
To — Material  Inventory, 

To  reverse  Inventory  of  1/1/20. 

(2) 
Material  Inventory, 
To — Material  Purchases, 

To  place  on  books  Inventory  of  12/31/20. 

(3) 
Manufacturing  Account,  $69,476.00 

To — Unfinished  Product  Inventory,  $69,476.00 

To  reverse  Inventory  of  1/1/20. 

(4) 
Unfinished  Product  Inventory,  $75,000.00 

To — Manufacturing  Account,  $75,000.00 

To  place  on  books  Inventory  of  12/31/20. 

(5) 
SelUng  Account,  #404,000.00 

To — Manufactured  Product  Inventory,  $404,000.00 

To  reverse  Inventory  of  1/1/20. 

(6) 
Manufactured  Product  Inventory,  $400,000.00 

To— Selling  Account,  $400,000.00 

To  place  on  books  Inventory  of  12/31/20. 
With  working  papers  constructed  as  above  indicated,  all  items  are 
readily  traceable,  especially  the  inventories.  Closing  entries  may  be  made 
directly  from  items  in  the  various  colimms  without  the  need  of  first  posting 
the  adjusting  entries.  The  preparation  of  the  Balance  Sheet  and  the 
Operating  Statements,  in  technical  form,  is  facilitated,  as  all  the  information 
necessary  is  given.    The  working  papers  are  continued  below. 


BALANCE  SHEET:  PROFIT  AND  LOSS  STATEMENT 


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338 


ADVANCED  ACCOUNTING 
THE  JONES  MANUFACTURING  CORPORATION 


Profit  and  Loss  Statement 

January  1,  1920,  to  December  31,  1920 

Exhibit  B 

Sales, 

$4,750,260.00 

Less — Return  Sales  and  Allowances, 

8,000.00 

Net  Sales, 

$4,742,260.00 

Deduct — Cost  of  Manufactured  Product  Sold, 

3,601,391.00 

Gross  Profit  on  Sales, 

$1,140,869.00 

Deduct: 

Selling  Expense: 

Advertising, 

$    5,000.00 

Salesmens'  Salaries, 

130,000.00 

Salesmens'  Traveling  Expense 

7,000.00 

Insurance — Manufactured  Product, 

450.00 

Freight  and  Cartage — Out, 

600.00 

Miscellaneous  Selling  Expense, 

3,000.00 

$145,950.00 

Net  Profit  on  Sales 

$994,909.00 

Deduct: 

General  Expense: 

Officers'  Salaries, 

170,000.00 

Office  Salaries, 

20,000.00 

Stationery  and  Printing, 

850.00 

Postage, 

700.00 

General  Expense, 

1,500.00 

Legal  Expense, 

4,000.00 

Depreciation — Furniture  and  Fixtures, 

275.00 

97,325.00 

Net  Profit  on  Operations, 

$897,684.00 

Deduct: 
Net  Interest — Discount,  Loss  on  Accounts  Receivable: 


Interest  on  Notes  and  Ac- 
counts Payable, 
Discount  on  Sales, 
Less — Discount  on  Purchases, 

Add— Bad  Debts  Written  off. 


$  2,500.00 
95,005.00 


$97,505.00 

43, 578  00 

$53,927.00 

4,000.00 


Net  Profit— January  1,  1920,  to  December  31,  1920, 


$  57,92700 
$839,667.00 


BALANCE  SHEET:  PROFIT  AND  LOSS  STATEMENT      339 
THE  JONES  MANUFACTURING  CORPORATION 
Statement  Showtng  Cost  of  Manufacture 

AND 

Cost  of  Manufactured  Product  Sold 
January  1,  1920.  to  December  31.  1920 

Cost  of  Manufacture: 

Unfinished  Product,   Inventory,  January  1 
1920,  ' 

Raw  Material: 

Inventory,  January  1,  1920,  $     500,000.00 

Purchases,  2,905,250.00 

Freight  and  Cartage  In,  j  qqq  qq 

_    ,           ^                                                        $3,  406,250.00 
Deduct— Inventory,  December  31,  1920,          450,000.00      2,956.250 00 
Direct  Labor, 

Manufacturing  Expense: 
Indirect  Labor, 


Exhibit  C 


$      69,476.00 


425,250.00 


Shop  Supplies, 

Factory  Expense, 

Heat,  Light  and  Power, 

Insurance — Factory, 

Taxes, 

Depreciation: 

Buildings,  $  4,500.00 

Machinery  and  Equipment,    7,500.00 
Patents,  11,765.00 


$  30,000.00 

101,000.00 

10,000.00 

39,000.00 

15,000.00 

2,650.00 


23,765.00  221,415.00 


Deduct— Unfinished  Product,  Inventory,  December  31 
1920,  ' 

Cost  of  Manufacture, 

Add— Manufactured  Product,    Inventory,   Januarv    1 
1920,  '      ' 

Deduct— Manufactured  Product,  Inventory,  December 
31,  1920, 

Cost  of  Manufactured  Product  Sold,  January  1.  1920  to 
December  31,  1920,  ~  ~ 


$3,672,391.00 

75,000.00 
$3,597,391.00 

404,000.00 
$4,001,391.00 

400,000.00 
$3,601,391.00 


t 
I 
I 


hi 


CHAPTER  X 
STATEMENT  ANALYSIS:  FOR  CREDIT  PURPOSES 

Introduction. — The  general  term  "statement  analysis"  is 
used  as  a  title  for  the  current  two  chapters  rather  than  the  more 
qualified  term  of  "analysis  of  corporate  statements"  because, 
even  though  the  corporate  statement  probably  is  the  one  most 
apt  to  be  considered  in  a  discussion  of  the  present  type,  the  basic 
principles  primarily  are  the  same  regardless  of  whether  a  state- 
ment under  analysis  be  that  of  a  sole  trader,  a  partnership,  or  a 
corporation. 

From  past  study,  it  should  be  remembered  that  two  primary 
statements  are,  or  at  least  should  be,  prepared  periodically  for 
a  business  enterprise : 

1.  Balance  Sheet. 

2.  Statement  of  Profit  and  Loss    (Statement  of  Profits  and 
Income). 

Although  one  may  be  inclined  to  say  that,  in  the  present  con- 
nection, the  Balance  Sheet  is  all  important,  it  should  not  be 
forgotten  that  the  Statement  of  Profit  and  Loss  is  both  com- 
plementary and  supplementary  thereto;  a  Balance  Sheet  cannot 
be  explained  rightly  unless  accompanied  by  a  Statement  of  Profit 
and  Loss.  A  person  may  encounter  one  without  the  other  and 
be  required  to  pass  judgment  thereon,  but  this  does  not  in  any 
way  refute  the  statement  that  both  should  be  available. 

In  considering  the  purposes  underlying  statement  analysis, 
two  viewpoints  present  themselves: 

1.  Is  there  a  credit  purpose  in  mind,  or 

2.  Is  there  an  investment  purpose  in  mind? 

Although  a  certain  similarity  exists  in  analyzing  a  statement 
for  either  of  these,  the  existent  differences  seem  so  prominent 
that  the  discussion  of  one  purpose  has  been  separated  from  a 
discussion  of  the  other. 

If  a  statement  is  being  analyzed  for  credit  purposes,  it  would 

340 


STATEMENT  ANALYSIS:  FOR  CREDIT  PURPOSES       341 

seem  that  one  first  ought  to  make  a  separation  relative  thereto 
as  between  credit  sources.    This  would  be  about  as  follows: 

1.  The  granting  of  credit  by  a  bank: 

a.  The  bank  in  a  relatively  small  community.  Here  the 
granting  of  credit  depends  upon  the  personal  element,  if 
not  more,  than  upon  the  mercantile  element. 

b.  The  bank  in  a  large  city.  Here  the  personal  element  is 
further  removed  than  under  (a).  Therefore,  the  grant- 
ing of  credit  depends  more  upon  the  mercantile  element 
than  upon  anything  else,— upon  the  ratio  of  good  current 
assets  to  current  liabilities,  cold  figures  from  which  work- 
ing capital  may  be  determined. 

2.  The  granting  of  credit  by  a  regular  business  concern.  Here 
both  the  elements  mentioned  above  are  taken  into  considera- 
tion, because  they  have  a  direct  bearing  upon  each  case  in 
hand. 

However,  let  it  be  remembered  that  when  the  professional 
accountant,  especially  the  C.  P.  A.,  is  called  upon  to  render 
judgment  as  to  a  credit  risk,  personal  protection  demands  that 
he  reach  a  decision  upon  nothing  except  cold  monetary  facts ; 
he  is  not  a  prophet. 

Credit.— Business  is  transacted  largely  upon  a  credit  basis. 
This  comprehends  the  advancement  of  values  for  a  promise  to 
make  a  return  at  a  later  date  either  of  the  values  which  have  been 
advanced,  or  of  money.  Such  an  advancement  of  values  is  made 
upon  the  belief  that  the  one  to  whom  they  are  advanced,  the 
vendee,  for  example,  will  meet  promptly  the  obligations  there- 
under assumed;  upon  such  belief,  the  vendee  secures  from  the 
vendor  the  title,  possession,  and  use  of  goods. 

Because  of  the  character  of  the  present  subject,  the  writer 
has  taken  the  liberty  of  considering  herein  certain  factors  not 
purely  of  an  accounting  nature  with  the  underlying  idea  that 
thereunder  a  more  comprehensive  understanding  of  the  topic 
will  result.  Credit  cannot  be  built  up  in  a  day;  it  may  take 
years  to  secure  a  great  credit  reputation.  But  one  misstep,  from 
a  lapse  of  judgment  or  from  a  lack  of  prudence,  may  destroy 
that  reputation  in  less  than  a  day.  Since  credit  news  travels 
rapidly,  such  destruction  is  apt  to  be  national  as  well  as  local. 


342 


ADVANCED  ACCOUNTING 


I'  • 


Personal  Versus  Mercantile  Credit.— All  credit  is  based 
fundamentally  upon  the  following  factors: 

1.  Personal  credit.  This  is  granted  to  individuals  or  concerns 
as  such,  depending  properly  upon  the  following: 

a.  Intent  or  character.  If  a  person  has  no  intention  of  meet- 
ing a  financial  obligation  when  the  latter  falls  due,  he 
is  deficient  in  morals  and  in  character;  he  is  dishonest. 
A  man  is  truly  dishonest  if  he  intends  to  accept  goods 
from  another  without  paying  the  obligation  arising  there- 
under. One  who  knowingly  extends  credit  to  such  a 
person  cannot,  in  any  sense,  be  considered  prudent. 
Character  and  intent  are  allied  closely.  Even  though 
character  influences  often  are  forgotten  in  passing 
upon  a  credit  risk,  as  would  be  the  case  of  a  practicing 
accountant  passing  judgment  upon  a  statement,  from  the 
business  man's  point  of  view,  it  would  seem  in  error  not 
to  consider  character;  a  borrower's  credit  is  affected  by 
such  practices  as  the  following: 

i.  Tricking  his  bank  in  any  way. 
ii.  Padding  his  accounts, 
iii.  Kiting  checks, 
iv.  Having  a  suspicious  fire, 
v.  Giving  customers  short  measure  or  weight. 
vi.  Securing  some  one  to  carry  his  note  or  open  ac- 
count when  he  has  pledged  secretly  his  merchan- 
dise and  book  accounts, 
vii.  Issuing  dishonest  statements, 
viii.  Bad  personal  habits, 
ix.  Engaging  in  some  form  of  graft  for  a  profit. 

b.  Capacity  or  ability.  The  ability  to  make  money  is  worth 
while  as  providing  the  means  whereby  a  debt  shall  be 
paid  upon  maturity.  It  is  a  factor  that  ought  not  be 
dispensed  with,  from  the  business  man's  viewpoint,  in 
passing  judgment  upon  a  credit  risk.  The  amount  of 
credit  granted  and  its  term  should  be  only  such  as  the 
income  can  meet  normally.  Ability  alone,  however,  is 
a  bad  discovery  in  a  credit  risk.  Ability  and  character 
go  hand  in  hand.  Character  alone  may  command  a  cer- 
tain amount  of  credit,  but  alone  it  cannot  settle  balances 


STATEMENT  ANALYSIS:  FOR  CREDIT  PURPOSES       343 

owing  another.    The  capacity  to  settle  must  accompany 
the  mtent  to  settle  if  unlimited  credit  is  desired. 
At  best,  in  most  cases,  personal  credit  granting  is  necessarily 
unscientific  for  lack  of  exact  data. 

2.  Mercantile  credit.  Mereantile  credit  is  on  a  better  basis 
than  personal  credit.  Less  exclusive  emphasis  is  placed 
upon  intent  or  character,  and  upon  capacity  or  ability,  than 
upon: 

a.  Capital  or  property.  Definite  evidence  of  property  and 
earnings  should  be  secured,  and  statements  should  be 
prepared  regularly  for  examination.  The  classes  loaned 
to  are  manufacturers,  wholesalers,  jobbers,  and  retailers. 
As  above  indicated,  the  business  man  should  not  deem 
this  factor  all-sufficient  in  granting  credit;  one  who  has 
capital  at  hand  in  the  beginning,  but  neither  character 
nor  ability  may  not  have  the  capital  at  hand  when  the 
time  arrives  to  make  settlement.  The  lack  of  char- 
acter and  ability  may  cause  the  capital  on  hand  at  the 
moment  credit  is  extended  to  be  dissipated  entirely  when 
the  settlement  date  arrives. 

b.  Security  or  collateral.     References  should  be  utilized 
whenever  a  credit  seeker  is  not  well  known;  bank  refer- 
ences are  best.    Personal  credit  may  be  secured  by  con- 
ditional bill  of  sale,  by  chattel  mortgage,  or  by  an  assign- 
ment.   However,   even  where   security   is   offered,   one 
should  make  certain  that  it  is  safe;  something  might 
be  wrong  with  the  security  offered,— it  might  have  been 
stolen  or  altered  in  some  way  or  another. 
No  two  credit  risks  are  alike;  two  concerns  may  submit  exactly 
the  same  type  of  statement  and  thereon,  from  the  accountant's 
viewpoint,  be  entitled  to  the  same  amount  of  credit;  but  in  some 
material  way  these  two  concerns  are  sure  to  be  dissimilar     The 
elements    of   judgment    and    discrimination    never    should    be 
forgotten. 

The  Credit  Department  and  Credit  Information.-Since 
credit  IS  granted  either  by  commereial  banks  or  by  mercantile 
concerns  to  their  customers,  it  seems  necessary  to  show  wherein 
the  two  differ  in  methods  as  well  as  wherein  they  are  similar 


M 


344 


ADVANCED  ACCOUNTING 


\\\ 


The  establishment  of  credit  departments  in  American  banks  has 
been  a  slow  process.     This  was  due  to  the  following: 

1.  Conservatism. 

2.  The  lesser  degree  of  indispensability  of  the  loaning  officers 
who  used  to  constitute  what  might  be  called  the  credit 
department. 

3.  Most  credit  was  granted  to  customers  whom  the  officers 
could  watch  closely. 

Modern  conditions  make  the  possession  of  such  a  department 
a  necessity  in  the  larger  banks  which  purchase  much  outside 
paper  or  are  called  upon  to  give  credit  information  to  corre- 
spondents, and  desirable  for  most  banks. 

In  most  respects  the  bank  credit  man  functions  like  other 
credit  men.  But,  if  anything,  he  must  play  safer  and  not  run 
the  risks  chanced  at  times  by  others,  because  the  bank  is  using 
other  people's  money.  He  must  know  something  of  many  lines 
of  business,  because  his  bank  will  be  called  upon  to  loan  to  indi- 
viduals and  concerns  in  varying  lines  of  activity. 

In  either  a  trading  or  manufacturing  establishment  business 
operations  follow  a  well-defined  sequence: 

1.  Purchase  of  materials  and  supplies.  This  is  the  work  of  the 
purchasing  department. 

2.  Storage.  This  is  the  work  either  of  the  stock  or  stores 
department. 

3a.  In  a  trading  concern: 

a.  Display  of  goods. 
3b.  In  a  manufacturing  concern: 

a.  Manufacturing  operations. 

4.  Sale  of  goods: 

a.  Sales  department.  Goods  are  sold  upon  either  a  cash  or 
credit  basis. 

b.  Credit  department.  When  a  sale  has  been  made  upon  a 
credit  basis,  this  department  passes  upon  the  risk.  In  a 
small  enterprise,  a  well-defined  department  may  not  be 
found,  one  man  or  two  doing  such  work  without  the 
actual  organization  of  a  department  for  that  purpose. 

In  the  manufacturing  or  trading  enterprise,  the  work  of  the 
credit  department  or  credit  man  comprises  the  "cooling  process," 
so  to  speak,  through  which  the  results  of  the  sales  department 


STATEMENT  ANALYSIS:  FOR  CREDIT  PURPOSES       345 

activities  dealing  with  credit  sales  should  pass  in  a  well  regulated 
organization.  This  cooling  process  has  the  following  as  its 
objects: 

1.  The  determination  of  the  security  of  both  the  working 
capital  which  has  been  advanced  to  customers  and  the 
profits  which  are  dependent  thereon. 

2.  The  granting  of  credit.  The  amount  of  credit  to  be  granted 
a  customer  should  not  be  determined  by  the  sales  depart- 
ment. The  methods  of  the  sales  department  look  wholly 
to  the  making  of  sales,  and  if  sales  enthusiasm  is  hindered 
m  any  way  by  the  idea  that  a  sale  cannot  be  closed  unless 
the  vendee's  credit  first  has  been  inquired  into,  the  selling 
of  goods  to  reliable  customers  would  suffer  to  a  marked 
degree. 

As  a  more  or  less  secondary  object,  the  credit  department  may 
be  given  the  work  of  collecting  the  accounts  past  due     If  the 
regular  monthly  billing  does  not  draw  forth  the  cash,  the  credit 
department  receives  the  past  due  accounts  from  the  bookkeeping 
department,  and  takes  the  steps  necessary  to  collect  thereon 
usually  being  guided  in  this  by  the  advice  of  attorneys. 
Credit  information  concerning  a  risk  is  secured  in  two  ways- 
1.  Directly.     Information  secured  by  the  credit  department 
itself  from  direct  information: 

a.  The  prospective  customer  may  submit  information,~a 
formal  statement  plus  oral  or  written  representations' 

b.  Information  may  be  secured  from  references  and  others 
who  know  the  prospect,— from  banks  and  from  the  trade 
in  answer  to  inquiries. 

c.  Local  credit  men's  associations  may  furnish  information 
concerning  a  prospective  customer. 

d.  Information  may  be  secured  from  the  accounting  depart- 
ment if  former  dealings  have  been  had  with  the  pros- 
pective customer. 

2.  Indirectly.  Financial  ratings  plus  general  and  special  re- 
ports may  be  secured  from  the  large  credit  agencies  which 
are  national  in  scope,  as: 

a.  R.  G.  Dun  &  Company. 

b.  The  Bradstreet  Company. 

These  agencies  collect  information   concerning  the  financial 


■ 


346 


ADVANCED  ACCOUNTING 


ability  of  practically  every  person  who  seeks  credit.  The  data 
is  collected  by  local  representatives,  and  cover  a  variety  of 
subjects: 

a.  Manner  in  which  one's  business  is  conducted. 

b.  Details  concerning  the  private  lives  of  individuals  in 
control  of  business  concerns. 

c.  Information  disclosed  by  newspaper  reports  and  Court 
records  concerning  judgments,  liens,  assignments,  bank- 
ruptcies, chattel  mortgages,  etc. 

This  information  is  reported  periodically,  and  upon  the  basis 
thereof  a  specific  amount  is  decided  upon  as  the  financial  worth 
of  each  business  investigated, — individual  including  firm,  and 
corporation.  And  upon  the  basis  of  this  financial  worth  a 
specific  credit  rating  is  determined.  These  ratings  then  are  com- 
piled and  published  in  book  form  and  yearly  subscriptions  are 
taken  therefor,  this  involving  the  payment  of  an  annual  fee. 
Each  subscriber  may  secure  regular  and  special  reports  in  addi- 
tion to  the  above  mentioned  rating  service  and,  upon  the  pay- 
ment of  special  fees,  may  secure  special  service.  These  agencies, 
as  a  rule,  maintain  a  collection  department  in  various  localities 
which  is  conducted  by  the  local  representative. 

All  the  data  covering  each  borrower  should  be  sorted  and  be 
compiled  in  readily  accessible  form.  Usually,  all  data  on  an 
individual  borrower  is  filed  in  a  single  folder.  The  net  result 
should  be  that  the  credit  department  will  have  on  hand  much 
accurate  and  up  to  date  information  for  ready  reference. 

Borrowers'  Statements. — Increasing  numbers  of  credit 
grantors  are  demanding  financial  statem.ents  irom  prospective 
borrowers.  Such  statements  are  the  backbone  of  the  information 
on  which  banks  purchase  commercial  paper.  Less  generally,  but 
increasingly,  especially  in  the  larger  cities,  banks  are  requiring 
financial  statements  as  a  basis  for  making  loans.  The  attempt 
by  banks  to  secure  paper  eligible  for  rediscount  with  their  Fed- 
eral Reserve  Bank  is  increasing  the  use  of  such  statements, 
especially  as  concerns  the  larger  loans.  These  statements  are 
used  more  widely  in  banking  than  in  the  extension  of  mercantile 
credit,  but  no  good  reason  exists  for  advocating  a  continuance  of 
such  practice ;  as  far  as  possible,  the  granting  of  mercantile  (credit 
should  be  upon  a  scientific  basis.    It  is  important  that  credit 


STATEMENT  ANALYSIS:  FOR  CREDIT  PURPOSES       347 

statements  should  be  recent,  not  over  six  months  old,  if  possible. 
Credit  information,  in  its  best  form,  is  presented  by  means  of 
the  two  primary  accounting  statements: 

1.  Balance  Sheet. 

2.  Statement  of  Profit  and  Loss. 

These  should  be  prepared  regularly  and  in  sufficient  detail  to 
prove  intelligible.  All  individuals  or  concerns  who  seek  credit 
will  not  supply  both  of  these  statements,  but  it  would  not  be 
insisting  too  much  to  require  them  to  do  so. 

These  statements,  sufficiently  complete  in  detail  and  certified 
to  by  a  qualified  accountant,  or  very  much  incomplete  and  per- 
haps certified  to  by  an  unqualified  practitioner,  must  be  analyzed 
carefully  by  the  credit  department.  At  present,  ideal  statements 
are  a  rarity;  in  fact,  they  may  be  everything  other  than  what  is 
desired  even  though,  as  generally  is  known,  the  Federal  Trade 
Commission,  by  the  aid  and  assistance  of  representatives  of  the 
American  Institute  of  Accountants,  have  evolved  a  most  ex- 
cellent  form  of  Balance  Sheet  and  Profit  Loss  Statement  de- 
signed  to  secure  uniformity  in  the  matter  of  credit  informa- 
tion. 

The  credit  department  analysis  will  include,  in  a  broad  way 
the  following: 

1.  Statement  comparisons.  One  or  more  past  periods  will  be 
compared  in  detail  with  the  present. 

2.  The  determination  of  the  causes  which  underlie  the  results 
shown. 

3.  The  determination  of  general  business  conditions  which 
underlie  the  particular  line  of  business  of  which  the  business 
under  scrutiny  is  a  unit  therein. 

The  detailed  analysis  necessary,  as  concerns  the  items  found 
upon  such  statements,  will  be  given  careful  consideration  later 
when  each  such  item  comes  up  for  discussion. 

As  indicated  already,  ideal  statements  are  uncommon,  but 
whether  ideal  or  not  they  must  be  studied  for  what  they  are 
worth.  If  not  inclusive  of  sufficient  information,  this  latter 
must  be  secured  before  credit  can  be  granted  intelligently.  And 
if  such  information  be  not  forthcoming,  the  only  sensible  thing 
to  do  is  to  refuse  credit  to  the  applicant. 

Of  the  two  statements  mentioned,  one  finds  the  Balance  Sheet 


348 


ADVANCED  ACCOUNTING 


II 


submitted  alone  rather  than  with  its  accompanying  income  state- 
ment. It  may  be  in  a  most  condensed  form;  usually,  it  is  thus 
presented.  It  may  be  without  a  certificate  of  a  reliable  account- 
ant; usually,  that  will  be  the  case.  Therefore,  it  seems  that 
since  the  Balance  Sheet  may  be  the  only  statement  submitted, 
it  is  logical  to  consider  this  first. 

The  Audited  Balance  Sheet. — ^Not  only  are  credit  grantors 
becoming  stricter  in  demanding  that  prospective  borrowers  pre- 
sent periodical  statements,  but  they  are  going  further  in  that, 
more  and  more,  would-be  borrowers  are  advised  to  have  their 
books  of  account  audited  regularly,  and  to  liave  statements  pre- 
pared therefrom,  by  professional  accountants,  particularly  by  a 
Certified  Public  Accountant,  who  should  attach  to  the  statements 
so  prepared  a  certificate  of  audit. 

For  the  protection  of  the  public,  the  Certified  Public  Account- 
ant works  under  a  certificate  or  license  granted  by  a  State,  and 
this  license  is  presumptive  evidence,  until  the  contrary  is  proved, 
that  the  holder  of  such  certificate  has  "a  sound  knowledge  of 
general  accounting  theory  and  a  broad  practical  training  in  the 
accounts  of  the  numerous  businesses  in  which  the  public  account- 
ant's services  may  be  required."  In  other  words,  the  holder  of 
such  a  certificate  is  presumed  to  be  thoroughly  competent  to  do 
this  kind  of  work.  The  holder  of  a  membership  in  the  American 
Institute  of  Accountants  would  be  presumed,  likewise,  to  be 
equally  thoroughly  competent  to  do  this  kind  of  work. 

The  value  of  a  statement  authenticated  by  a  competent  and 
impartial  critic  cannot  be  stressed  too  much.  The  certificate 
of  a  competent  accountant  represents  the  opinion  of  a  disinter- 
ested party,  who  is  assumed  to  know  his  business,  concerning  the 
condition  of  the  enterprise  under  scrutiny  rather  than  a  mere 
compilation  of  figures  prepared  either  by  the  concern  itself  or 
by  an  incompetent  outsider. 

Statements  prepared  by  the  concern  itself  are  inclined,  even 
without  dishonest  intention,  to  be  most  liberal  as  concerns  the 
cash  realization  of  some  of  the  company's  assets.  Statements 
prepared  by  incompetent  outsiders  are  apt  to  reflect  the  attitude 
of  the  officials  of  the  concern  for  whom  the  work  is  being  done, 
rather  than  being  an  unbiased  disinterested  opinion  of  conditions. 

One  of  the  first  things  to  determine,  therefore,  is  to  notice  if 


STATEMENT  ANALYSIS:  FOR  CREDIT  PURPOSES       349 

the  Balance  Sheet  has  been  certified  to  by  a  competent  account- 
ant. Next,  one  must  ascertain  the  reputation  of  the  accountant 
who  prepared  it.  In  this  connection,  the  certificate  need  not 
necessarily  be  from  a  large  firm  of  accountants,  inasmuch  as  the 
small  fellow  may  do  just  as  good  work  as  the  large  firm.  Third, 
one  should  examine  the  certificate  to  ascertain  its  nature.  The 
certificate  of  a  competent  practitioner  should  be  sufficient  to 
insure  that  the  statement  means  what  it  seems  to  mean,— that 
it  is  technically  correct;  it  does  not  guarantee,  however,  the 
exact  truth  of  the  facts  since,  at  best,  the  latter  is  only  an 
opinion.  Any  limitations  in  the  certificate,  frankly  expressed  or 
implied,  should  be  noted  carefully;  thus,  if  an  auditor  specifies 
what  he  has  done,  it  is  fairly  certain  he  has  done  nothing  else. 
The  crucial  point  in  any  Balance  Sheet  presented  for  credit 
purposes  usually  is  the  inventory.  The  auditor  may  test  this 
in  various  ways,  as  by  footing  sample  pages,  testing  valuations, 
etc.,  but  often  this  is  not  done.  Auditors  neither  are  appraisers 
nor  valuers  in  the  strict  sense  of  the  word,  inasmuch  as  this 
task  belongs  to  an  appraisal  company. 

Credit  and  the  Balance  Sheet.— The  payment  of  a  financial 
obligation  on  due  date  depends  upon  having  the  right  kind  of 
assets  at  hand  with  which  to  make  payment,  usually  cash.  Since 
liabilities,  as  a  rule,  must  be  paid  in  cash,  a  deficiency  in  the 
amount  of  cash  so  required  leans  toward  opening  a  condition  of 
insolvency,  which  makes  the  credit  risk  thereunder,  naturally,  a 
poor  one;  a  full  liquidation  under  such  circumstances,  as  a  rule, 
will  be  impossible. 

If  credit  is  to  be  advanced,  a  solvent  condition  must  be  main- 
tained and,  in  determining  the  existence  or  non-existence  of  such 
a  condition,  the  properly  prepared  Balance  Sheet  is  of  marked 
importance.  A  merchant  who  files  a  Balance  Sheet  regularly 
with  his  banker  is  doing  one  of  the  best  things  possible  toward 
strengthening  his  own  credit;  it  is  really  more  to  the  advantage 
of  a  merchant  to  file  this  statement  with  his  banker  than  to  have 
the  latter  request  it. 

The  arrangement  of  the  items  upon  a  Balance  Sheet  depends 
more  or  less  upon  the  ideas  of  the  constructor  toward  bringing 
out  the  most  salient  points  in  connection  therewith.  In  general, 
however,  when  a  Balance  Sheet  is  being  prepared  for  credit  pur- 


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ADVANCED  ACCOUNTING 


poses,  or  is  being  recasted  and  analyzed  by  a  credit  man  through 
a  process  of  elimination  in  order  to  bring  out  prominently  certain 
leading  features  concerning  financial  condition,  the  asset  and 
liability  items  thereon  are  separated  into  two  fundamental 
groupings: 

1.  Current  (operating). 

2.  Capital  (fixed  or  permanent). 

The  current  items  are  of  more  importance  to  the  creditor  than 
the  capital  items  and,  therefore,  require  the  most  careful  detailed 
discussion  as  against  a  sunmiary  discussion  of  those  grouped 
under  the  heading  of  "capital."  The  operating  items  bear  upon 
solvency  and  upon  the  liquidation  of  liabilities  in  the  usual 
course  of  events ;  whereas,  the  permanent  items  are  of  secondary 
consideration  in  that,  although  connected  prominently  with  cur- 
rent financing  they  are,  to  creditors,  merely  an  indicator  of 
secondary  or  reserve  strength  and  security.  The  credit  Balance 
Sheet  should  be  prepared,  preferably,  in  the  account  form  under 
which  the  current  assets  are  displayed  in  opposition  to  the  cur- 
rent liabilities;  such  display  makes  possible  a  ready  comparison 
between  the  relative  values  of  the  two  totals.  The  difference 
between  these  two  tables  represents  "working  Capital"  and,  when 
analyzing  a  Balance  Sheet  for  credit  purposes,  two  of  the  first 
questions  to  be  answered  are: 

1.  What  is  the  amount  of  the  working  capital? 

2.  What  is  the  relation  of  the  working  capital  to:' 

a.  The  total  capital? 

b.  The  needs  of  the  business? 

The  probabilities  as  to  solvency  may  be  determined  in  their 
major  import  from  an  examination  of  the  current  assets  as 
against  current  liabilities,  as  follows: 

1.  The  relation  of  current  assets  to  ciwrent  liabilities.  Credit 
men,  ordinarily,  look  for  a  2  to  1  ratio  or  condition  relative 
to  the  current  items ;  they  desire  to  see,  in  other  words,  $2.00 
of  quick  assets  on  hand  with  which  to  discharge  $1.00  of 
current  debt.  If  a  Balance  Sheet  varies  from  this  condition, 
the  reason  therefor  must  be  determined.  The  above  indi- 
cated ratio  is  not  an  absolute  standard,  being  simply  a 
working  rule. 

2.  The  convertibility  of  assets  to  a  realized  basis.    If  a  forced 


STATEMENT  ANALYSIS:  FOR  CREDIT  PURPOSES       351 

sale  is  necessary  to  secure  the  cash  with  which  to  pay  obli- 
gations maturing  and  matured,  the  current  assets,  as  inven- 
tories, must  be  sacrificed  to  a  more  or  less  extent. 
3.  The  extent  to  which  liabilities  may  be  renewed.    The  capi- 
tal assets  which  are  not  encumbered  by  specific  liens,  as  a 
mortgage   (liens  falling  due  more  than  ninety  days  from 
date  of  the  statement) ,  are  considered  only  as  additional 
security  available  in  an  emergency. 
Too  much  stress  cannot  be  laid  upon  the  importance  of  a 
proper  analysis  of  the  Balance  Sheet.    The  Balance  Sheet  is  a 
photograph  of  the  business  and,  if  not  viewed  correctly,  the  whole 
complexion  of  the  risk  is  altered  and  the  possibilities  of  use 
defeated. 

The  Problem  of  Current  Financing.— Not  all  current 
assets  can  be  used  directly  for  the  purpose  of  meeting  maturing 
obligations,  because,  eventually,  these  latter  must  be  paid  in 
cash.  The  further  back  one  goes  from  cash,  as  an  asset,  toward 
inventories  of  finished  or  raw  product,  as  assets,  the  less  avail- 
able becomes  the  asset  of  cash  for  the  purpose  of  meeting  matur- 
ing liabilities  and,  the  less  available  the  cash,  the  less  desirable 
becomes  the  risk  for  credit  purposes. 

Current  liabilities  mature  within  from  sixty  to  ninety  days. 
Normally,  notes  payable  may  be  renewed  in  part,  but  too  much 
reliance  should  not  be  placed  upon  this  means  of  replenishing 
the  cash  fund  needed  for  liquidation  purposes;  an  abnormal 
condition  will  throw  all  estimates  awry.  One  must  always  count 
upon  the  fact  that,  even  under  normal  conditions,  a  large  portion 
of  the  current  liabilities  must  be  paid  when  due. 

Ordinarily,  therefore,  the  keen  business  man  will  make  use  of 
a  number  of  legitimate  expedients  to  secure  a  current  cash  fund 
of  the  right  size  for  the  purposes  of  his  organization.     Of  the 
methods  used,  the  following  three  illustrate  how  current  financ- 
ing is  accomplished: 
1.  The  purchase  of  merchandise,  materials,  and  supplies  on  a 
credit  basis.    This  is  the  usual  way  of  doing  business  even 
though  it  entails  the  loss  of  cash  discounts  which  in  turn 
amounts  to  borrowing  funds  at  a  heavy  rate  of  interest. 
The  idea  here  underlying  is  to  use  the  values  belonging  to 
some  one  else  to  help  conduct  the  business,  as  by  purchasing 


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ADVANCED  ACCOUNTING 


upon  a  sixty-day  net  basis  and  selling  on  a  cash  or  ten-day 
basis.  The  amount  of  aid  so  received  depends  upon  the 
quantities  of  goods  found  on  the  shelves  awaiting  sale  as 
against  the  time  they  remain  there. 

2.  Borrowing  upon  commercial  paper.  The  liability  arising 
therefrom,  normally,  may  be  carried,  within  a  reasonable 
amount,  for  a  longer  period  of  time  without  a  final  settle- 
ment being  necessary  than  the  liability  arising  under 
accounts  payable,  because: 

a.  Renewals  thereof  may  be  secured  from  time  to  time. 

b.  Conversion  thereof  may  be  made  upon  maturity. 
Nevertheless,  the  amount  of  such  liability  should  not  be  too 

large  because,  if  so,  a  dangerous  condition  exists.  Regardless 
of  the  two  possibilities  above  shown  this  dangerous  tendency 
arises  because: 

a.  Notes  mature  at  definite  times  and  some  must  then  be 
paid  even  though  a  portion  may  be  renewed  or  converted. 

b.  When  notes  mature,  the  possibility  of  renewal  cannot 
well  be  measured  because  the  holders  have  the  privilege 
of  calling  for  payment. 

c.  If  notes  are  not  paid  promptly  when  called,  they  are 
subject  to  protest. 

d.  Notes  carry  interest. 

3.  Advancement  of  services  by  employees  for  current  opera- 
tions. If  payday  is  a  week  later  than  the  time  at  which  the 
payroll  is  calculated,  there  exists  an  average  continual 
advance  by  employees  equal  in  amount  to  the  payroll  for 
two  weeks.  Part  of  such  advance  is  absorbed  by  partly 
manufactured  goods. 

General  Principles  of  Analysis — Further  Discussion. — 
Every  concern  should  finance  its  fixed  assets  from  its  fixed 
(capital)  or  slow  liabilities  and  preferably  from  its  capital  (pro- 
prietorship element)  alone;  it  should  finance  its  quick  assets 
from  its  quick  liabilities  and  from  its  capital.  In  the  extension 
of  long-time  credit,  all  factors  with  regard  to  the  business  should 
be  investigated  carefully;  for  purposes  of  extending  short-time 
credit,  such  a  thorough  review  is  unnecessary. 

As  indicated  already,  the  quick  assets  and  liabilities  are  to  be 
noted  chiefly  and  be  compared,  the  examiner  attempting  to 


STATEMENT  ANALYSIS:  FOR  CREDIT  PURPOSES       353 

assure  himself  that  the  quick  assets  are  adequately  in  excess  of 
the  qmck  liabilities;   the  quick   assets  must  repay  the  loan 
Practically  all  assets,  as  stated,  are  subject  to  shrinkage;  the 
excess  of  quick  assets  over  quick  liabilities  is  necessary: 

1.  To  take  care  of  this  shrinkage. 

2.  To  provide  for  unexpected  slowness  in  realizing  upon  the 
quick  assets. 

3.  To  cover  unusual  loss  due  to  unfavorable  business  con- 
ditions. 

4.  To  cover  any  possible  contingent  liabilities. 

5.  To  provide  for  a  factor  of  safety. 

Opinions  differ  as  to  the  ratio  of  quick  assets  to  quick  liabili- 
ties, especially  since  some  businesses  require  more  margin  than 
others,  and  since  it  is  dependent  somewhat  upon  whether  or  not 
the  concern  under  scrutiny  does  a  seasonal  business.  As  has 
been  indicated,  2  to  1  is  the  usual  ratio.  Some  safe  concerns 
dealing  in  very  quickly  moving  staples,  such  as  groceries  or 
meats,  may  be  given  safely  a  ratio  of  II/2  to  1.  One  writer 
states  that  notes  and  accounts  payable  should  be  covered  by 
cash,  notes  and  accounts  receivable,  and  that  there  should  be  as 
much  merchandise  besides.  If  cash,  notes  and  accounts  receiv- 
able be  less  than  the  quick  liabilities  named,  the  ratio  should 
be  at  least  2i^  to  1 ;  if  more,  the  ratio  safely  may  be  less  than 
2  to  1,— that  is,  the  merchandise  need  not  equal  the  quick 
liabilities. 

Loans  are  limited  sometimes  in  amount  by  the  rule  that  the 
loan  should  not  exceed  one-fourth  to  one-third  of  the  excess  of 
quick  assets  over  quick  liabilities.  A  more  reasonable  rule 
would  seem  to  be  to  decide  upon  the  ratio  to  be  maintained 
between  the  quick  assets  and  the  quick  liabilities,  as  to  the  case 
in  hand,  and  then  not  loan  more  than  will  permit  the  retention 
of  this  ratio  after  the  loan  is  made. 

Turnover  should  be  noted  as  a  means  of  judging  the  activity 
of  the  business  and  its  assets,  and  of  comparing  them  with 
typical  figures  for  similar  businesses.  Turnover  is  computed  by 
dividing  the  average  annual  sales  by  the  average  inventory  or 
stock  on  hand.  Retail  prices  should  be  used  in  both  cases,  or 
cost  prices  should  be  used  in  both  cases.  The  higher  the  turn- 
over, the  more  active  the  business.     Where  annual  sales  are  not 


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stated,  they  may  be  deduced  roughly  from  the  accounts  and 
notes  receivable  in  connection  with  the  terras  of  credit  usually 
given  on  sales. 

After  one  ascertains  that  the  ratio  of  current  assets  to  current 
liabilities  apparently  is  satisfactory,  the  differentiations  of  the 
report  may  be  analyzed  and  compared  to  determine  whether  the 
satisfactory  ratio  will  stand  the  acid  test  of  scrutiny  and  criti- 
cism. The  order  of  analysis  follows  personal  preference  but,  as 
a  rule,  the  assets  are  considered  first,  those  of  a  current  nature 
being  scrutinized  the  most.  However,  the  fixed  or  capital  assets 
should  not  be  forgotten  because: 

1.  Of  the  amount  of  carrying  charges,  as  interest,  that  they 
may  involve. 

2.  Of  the  ultimate  realizable  value,  as  a  source  of  secondary 
strength,  that  they  may  have. 

Cash. — This  current  asset  should  mean  exactly  what  the  term 
indicates  and  nothing  else.  The  amount  of  cash  one  should  find 
must  be  large  enough  to  balance  the  statement  properly,  divided 
as  between  cash  on  hand  and  cash  on  deposit.  A  large  amount 
of  cash  is  taken,  generally,  to  indicate  a  healthy  condition  al- 
though, if  too  large,  it  might  be  cause  to  have  business  sagacity 
reflected  adversely  in  that  the  excess  amount  over  that  which 
actually  is  required  ought  to  be  earning  more  interest  than  the 
small  percentage,  if  any,  allowed  by  banks  upon  deposits.  Again, 
if  a  large  sum  of  cash  is  noticed,  one  should  ascertain  whether 
or  not  it  has  been  accumulated  for  definite  expenditures  in  the 
near  future, — as  dividend  distribution,  salary  payments,  or  even 
cash  purchases  in  order  to  take  advantage  of  a  reduction  in 
ordinary  prices  charged. 

A  continued  small  cash  balance  plus  a  large  aggregate  of  out- 
standing obligations  and  sales  indicate  poor,  if  not  reckless, 
financing.  The  amount  of  the  cash  fund  is  decidedly  important 
from  the  viewpoint  of  current  financing;  maturing  obligations 
eventually  must  be  paid  in  cash,  and  if  the  cash  fund  proves  to 
be  inadequate  disaster  may  not  be  far  off,  especially  if  a  turn  in 
the  money  market  is  at  hand. 

In  some  cases,  a  nominal  cash  item  is  shown  due  to  the  con- 
cern's practice  of  using  a  large  portion  of  its  available  cash 
to  retire  outstanding  obligations  just  prior  to  the  date  of  the 


STATEMENT  ANALYSIS:  FOR  CREDIT  PURPOSES       355 

Balance  Sheet.  Again,  cases  have  been  found  where  a  concern 
has  applied  its  cash  to  the  reduction  of  its  payables  without  an 
actual  retirement  of  that  indebtedness  in  the  amount  assumed; 
this  merely  is  a  bookkeeping  transaction  by  which  a.  reduction 
of  an  equivalent  amount  is  made  in  both  cash  and  payable  items. 
Such  practice  cannot  be  condoned  in  any  way  because,  when 
permitted,  the  submitted  Balance  Sheet  does  not  show  the' actual 
condition  of  the  business. 

Business  activity  usually  fluctuates  seasonally.  With  a  de- 
crease in  output,  indicating  the  introduction  of  a  period  of  lessen- 
ing activity,  there  will  be,  normally,  a  decrease  in  the  amount  of 
cash  riBquired.  And  when  output  increases,  notes  and  accounts 
payable  increase  proportionately  with  the  result  that  there 
should  be  a  corresponding  increase  in  cash.  When  this  fund  is 
small,  it  still  must  be  large  enough,  in  general,  to  meet  current 
requirements,  and  to  do  so. 

Although  a  certain  amount  of  cash  may  be  secured  by  borrow- 
ing, the  source  is  not  reliable.  And  if  borrowing  is  resorted  to, 
care  must  be  used  not  to  overstep  in  waiting  for  the  moment 
at  which  to  borrow  in  order  to  save  a  trifle  in  interest;  when  the 
very  last  moment  arrives,  it  may  be  impossible  to  secure  funds 
by  borrowings. 

In  determining  upon  the  sufficiency  of  the  cash  fund,  two 
points  of  major  importance  must  be  observed: 

1.  The  time  required  within  which  to  convert  unrealized  cur- 
rent assets  into  cash. 

2.  The  exact  maturity  dates  of  outstanding  obligations.  The 
longer  it  takes  to  convert  current  assets  into  cash,  and  the 
quicker  the  liabilities  mature,  the  larger  must  be  the  avail- 
able cash  fimd. 

Most  commercial  banks,  in  making  loans  to  customers,  en- 
deavor to  have  the  latter  maintain  a  cash  balance  with  them 
equal  to  about  20  per  cent  of  the  amount  of  the  loans  made. 
A  nommal  cash  item,  therefore,  compared  to  notes  payable  due 
banks  indicates  that  the  banks  of  deposit  are  not  being  treated 
liberally  in  the  way  of  balances. 

One  should  ascertain  whether  the  it^m  of  cash  includes  time 
certificates  of  deposit  because,  while  these  represent  actual  cash 
on  deposit,  they  may  be  pledged  for  loans  and  such  fact  might 


356 


ADVANCED  ACCOUNTING 


HI' 


not  be  shown  anywhere  upon  the  face  of  the  Balance  Sheet. 
When  so  pledged,  the  funds  represented  by  such  certificates 
are  tied  up  until  the  loans  mature;  although  such  a  case  is 
unusual,  it  should  be  borne  in  mind. 

If  possible,  one  should  make  sure  the  cash  account  does  not 
include  such  items  as  demand  notes,  or  I.  ().  U's,  covering  with- 
drawals, expenses  or  loans  to  officers  or  employees;  such  items 
are  not  readily  available  for  the  needs  of  the  business.  The 
same  would  be  true  of  sums  on  deposit  with  enterprises  in  the 
process  of  liquidation. 

Notes  or  Bills  Receivable — Acceptances. — Notes  or  bills 
receivable  may  originate  in  two  ways: 

1.  From  customers,  if  primarily  connected  with  trading. 

2.  From  actual  loans  made  for  which  negotiable  paper  haa 
been  received,  if  not  directly  connected  with  trading. 

In  either  event,  if  the  total  be  large,  it  is  necessary  to  know 
of  what  it  consists.  A  business  in  which  long  time  credits  are 
given,  or  one  in  which  the  working  capital  is  less  than  it  should 
be,  are  familiar  examples  in  which  the  total  notes  or  bills  receiv- 
able are  large.  Contractors,  dealers  in  lumber,  fur,  silk,  automo- 
biles, agricultural  machinery,  etc.,  will  have,  usually,  a  large 
portion  of  their  current  assets  in  the  form  of  notes  receivable, — - 
instalment  notes.  Again,  a  large  notes  receivable  item  may  in- 
dicate unfavorable  business  conditions  prevailing  in  the  com- 
pany's locality.  In  general,  a  large  amount  thereof  is  an  un- 
favorable indication;  certainly,  if  the  accounts  receivable  are 
large,  there  should  be  few  notes  receivable. 

If  this  item  is  not  to  be  regarded  with  suspicion,  it  must  not 
contain  questionable  elements,  as: 

1.  Advances  to  ofl&cers,  employees,  stockholders. 

2.  Notes  renewed  several  times. 

3.  Notes  covering  unpaid  stock  subscriptions. 

4.  Dishonored  paper. 

5.  Kited  paper. 

6.  Notes  due  from  subsidiaiy  or  aflSliated  interests. 

7.  Accommodation  notes. 

8.  Hypothecated  notes. 

Notes  to  which  the  odium  of  the  above  elements  is  attached 
should  be  withdrawn  from  the  current  assets  and  be  placed 


STATEMENT  ANALYSIS:  FOR  CREDIT  PURPOSES       357 

among  the  slow  assets  if  retained  at  all  as  assets.    Many  of  these 
types  of  notes  would  prove  uncollectible  in  case  of  failure. 

Further,  a  certain  allowance,  usually,  should  be  made,  over 
and  above  that  already  calculated,  for  further  depreciation  of 
this  item.  This  further  allowance  may  not  be  indicated  by  writ- 
ing down  any  actual  figures,  being  merely  borne  in  mind  when 
judgment  is  formed  concerning  the  net  value  of  the  company's 
receivables. 

Short  term  notes  are  more  desirable  than  long  term  notes.  At 
times,  notes  receivable  are  secured  by  real  estate  or  by  some 
other  collateral.  When  thus  found,  the  impression  arises  that 
prompt  collectibility  is  not  possible ;  consequently,  if  the  amount 
be  large,  a  word  of  explanation  from  the  customer  would  be  in 
order. 

Where  companies  sell  their  goods  upon  an  acceptance  basis, 
the  acceptances  received  are  available  for  two  purposes: 

1.  For  discount  with  their  bankers. 

2.  For  disposal  in  the  open  market. 

Under  such  procedure,  the  concern's  necessity  of  borrowing 
upon  their  own  notes  is  eliminated.  The  discount  or  sale  of  such 
acceptances  constitutes  a  contingent  liability  unless  made  "with- 
out recourse." 

Accounts  Receivable.-This  item  should  not  be  excessive  in 
amount,  and  there  should  be  very  little  of  them  if  notes  receiv- 
able  are  taken  largely.  They  should  represent  good  live  ac- 
counts as  far  as  it  is  possible  for  human  endeavor  to  so  ascer- 
tarn.  Too  often,  in  fact,  where  a  set  of  books  has  been  more  or 
less  incorrectly  kept,  it  is  found  that  this  item  has  been  juggled 
so  that  the  increase  in  surplus  as  shown  on  the  Balance  Sheet 
will  equal  the  amount  of  net  profit  per  Statement  of  Profit  and 
Loss. 

In  general,  the  following  information  should  be  secured  from 
a  scrutiny  of  this  item: 

1.  Soundness.  Have  all  doubtful  accounts  been  eliminated 
and  are  they  due  from  customers  for  merchandise  sold  in 
the  usual  course  of  business,  or  are  they  due  from  others? 

2.  Relation  of  total  amount  to  the  total  of  the  working  assets. 

3.  Ratio  of  the  total  both  to  the  total  sales  of  the  period  and 
to  the  terms  upon  which  goods  are  sold  in  the  branch  of 


358 


ADVANCED  ACCOUNTING 


trade  of  which  the  case  under  review  is  a  fair  representa- 
tive; the  turnover  must  be  correctly  proportioned. 

4.  Conditions  governing  realization. 

5.  Proportion  charged  up  for  future  delivery  which,  under 
adverse  conditions  and  a  break  in  prices,  would  prove 
useless  as  an  asset. 

6.  Proportion  pledged  for  loans.  This  is  a  sign  that  the  appli- 
cant is  hard  pressed  to  secure  credit. 

7.  Proportion  due  from  affiliated  concerns  or  from  persons 
closely  associated  with  the  business. 

When  a  large  volume  of  open  accounts  receivable  is  noticed, 
one  may  believe,  without  error,  that  a  loss  will  be  suffered  when 
it  is  attempted  to  realize  upon  the  accounts.  Therefore,  under 
such  condition,  a  reserve  should  be  present  to  cover  the  amount 
of  such  probable  loss;  if  such  reserve  be  not  present,  the  asset 
value  of  the  accounts  receivable  may  be  considered,  without 
hesitation,  as  being  inflated. 

The  relation  of  the  total  amount  of  accounts  receivable  to 
the  total  of  the  working  assets  is  of  major  importance  in  connec- 
tion with  the  terms  under  which  settlement  is  to  be  made  in 
that  such  relationship  affects  the  amount  of  the  available  cash 
fund.  Accounts  which  cannot  be  liquidated  except  after  the 
passage  of  a  considerable  period  of  time  are  not  as  desirable 
as  those  which  may  be  liquidated  within  a  short  interval  of  time. 
In  the  instalment  business,  for  example,  the  proportion  of  the 
accounts  receivable  in  relation  to  the  inventories  will  be  rela- 
tively large,  whereas,  in  a  retail  business  conducted  on  a  cash 
basis  the  proportion  thereof  as  related  to  inventories  should  be 
decidedly  small.  In  the  first  instance,  the  working  capital  needed 
will  be  relatively  large,  whereas,  in  the  latter  case  it  will  be 
relatively  small.  Since  a  large  amount  of  long  time  accounts 
may  encumber  the  ease  of  securing  cash,  and  a  small  amount  of 
short  time  accounts  may  assist  the  ready  securement  of  cash,  a 
small  amount  of  short  time  accoimts  may  be  more  available, 
from  the  cash  viewpoint,  than  a  large  amount  of  long  time 
accounts.  Large-sized  inventories  plus  a  large  amount  of  ac- 
counts receivable  indicate  slow  convertibility  which,  in  turn, 
points  out  the  need  of  a  large  amoimt  of  working  capital. 

Indebtedness  due  from  affiliated   concerns    (which   concerns 


STATEMENT  ANALYSIS:  FOR  CREDIT  PURPOSES       359 

might  be  operating  as  branches— in  the  case  of  distributors,  or 
as  producers  in  allied  lines— in  the  case  of  manufacturers)  should 
not  be  included  in  the  quick  assets,  because,  while  they  may  be 
liquidated  in  part  from  time  to  time,  they  are  more  or  less 
of  a  permanent  character  (dependent  upon  the  line  of  business) , 
and  frequently  represent  the  investment  made  in  the  subsidiary 
or  affiliated  company.  In  the  event  of  liquidation,  these  funds 
usually  are  not  found  to  be  of  full  realizable  value. 

Inventories:  Materials,  Supplies,  and  Merchandise.— The 
inventory  item,  usually,  is  the  most  important  of  all  the  current 
assets  and,  as  a  rule,  constitutes  the  major  portion  thereof.  This 
item  always  is  considered  as  being  a  quick  asset,  but  since,  as 
a  rule,  it  is  an  asset  which  moves  the  slowest  of  the  usual  current 
assets,  one  should  question  closely  its  ready  convertibility.  Be- 
fore going  further,  consider  the  inventory  of  a  manufacturing 
concern,  as  representing  the  most  complicated  type,  and  notice 
its  components: 

1.  Raw  materials.  Many  kinds  of  raw  material  may  be  used 
and  most  of  it  may  be  secured  far  in  advance  of  the  time 
at  which  it  will  be  used. 

2.  Goods  in  process.  This  represents  goods  being  fabricated 
but  not  yet  completed,  its  value  being  composed  of  the  cost 
of  material  and  labor  with  perhaps  a  certain  portion  of  the 
factory  overhead. 

3.  Finished  product.  These  are  goods  which  are  manufactured 
and  ready  for  sale. 

4.  Miscellaneous. 

One  of  the  first  things  to  observe  relates  to  overstocking. 
This  may  or  may  not  represent  something  which  is  indicative  of 
undesirability: 

1.  Overstocking  may  be  due  to  foresightedness  in  making  large 
purchases  in  a  favorable  market,  or  to  the  fact  that  the 
company  is  distant  from  its  source  of  supply,  or  because 
of  seasonal  demands. 

2.  Overstocking  may  be  due  to  shortsightedness  which  indi- 
cates bad  management  in  that  the  purchase  prices  are  so 
high  that  a  price  decline  will  come  later.  If  such  condition 
exists,  great  care  must  be  observed  before  passing  favorably 


360 


ADVANCED  ACCOUNTING 


upon  the  risk,  because  such  an  overstocking  may  be  a 
menace  rather  than  a  help. 

Again,  where  a  concern  is  manufacturing  machines  of  one  sort 
or  another,  a  large  portion  of  the  inventory  may  represent  re- 
pair or  replacement  parts.  Naturally,  these  are  slow  to  realize 
cash  from  and  harm,  rather  than  support,  the  convertibility 
feature  of  the  inventory.  Inventories  in  the  nature  of  special- 
ties are  not  as  desirable  as  those  of  staple  value;  the  former 
require,  usually,  continued  advertising  in  order  to  move  them. 
Also,  staple  stocks  with  a  ready  market  are  more  available  for 
current  purposes  than  raw  stock  which  must  be  processed  before 
being  marketed.  More  depreciation  must  be  allowed  for  luxur- 
ies, novelties,  and  seasonable  goods  than  for  staples. 

Inventories  should  be  valued  at  cost  or  market,  whichever  is 
lower.  If  market  price  at  inventory  date  is  less  than  cost,  it  is 
well  to  provide,  also,  for  further  shrinkage  due  to  increased 
selling  expenses,  etc.  Where  market  price  is  not  readily  deter- 
mined, sales  price  may  be  taken  and  be  reduced  by  the  percent- 
age of  mark-up  used  in  the  business.  Valuation  accuracy  is  de- 
cidely  important.  The  takers  of  the  inventory  and  the  methods 
used  in  taking  it  should  be  ascertained,  if  possible;  and  in  this 
connection,  the  best  evidence  securable  as  to  accuracy  is  the 
audit  certificate  of  a  competent  accountant. 

All  slow  stock  should  be  depreciated  heavily,  and  all  unsalable 
stock  either  should  be  eliminated  entirely  from  the  inventory  or 
be  given  a  movable  valu^^tion.  Inventory  turnover  is  important ; 
the  credit  examiner  should  be  familiar  with  the  customary  turn- 
over in  the  line  of  business  represented  by  the  concern  whose 
statement  is  under  the  microscope.  If  goods  are  scattered  in  a 
number  of  places  over  the  country,  a  most  efficient  main  office 
organization  is  necessary  to  prepare  the  figures  properly;  more 
than  ordinary  care  and  system  are  necessary. 

More  than  one  plant,  small  and  large,  secure  their  desired 
ratio  between  current  assets  and  current  liabilities  by  inventory 
juggling,  and  this  the  would-be  creditor  cannot  discover  without 
great  difficulty,  if  at  all.  Therefore,  as  mentioned  above,  the 
best  evidence  securable  as  to  inventory  accuracy  is  the  audit 
certificate  of  a  competent  practitioner,  a  C.  P.  A.,  or  member 
of  the  American  Institute  of  Accountants. 


STATEMENT  ANALYSIS:  FOR  CREDIT  PURPOSES       361 

The  relation  of  the  inventories  to  the  entire  current  asset 
fund  is  most  important.  If  the  amount  is  large  and  out  of  pro- 
portion to  the  indicated  needs  of  the  enterprise,  the  reason  there- 
for may  be  one  of  the  following: 

1.  Speculative  purchasing. 

2.  Overstocking  (commented  on  above). 

3.  Inflation  in  values. 

On  the  other  hand,  if  the  amount  is  small  and  out  of  propor- 
tion to  the  needs  of  the  business,  we  have  the  earmarks  of  a 
hand-to-mouth  policy.  But  in  connection  with  the  above  two 
possibilities,  it  should  be  remembered  that  each  particular  line 
of  business  must  be  judged  by  the  conditions  thereunder  exist- 
ing rather  than  by  general  rules  designed  to  cover  all  lines  of 
business  endeavor.  If  the  amount  of  this  asset  is  out  of  pro- 
portion to  the  required  current  asset  fund,  and  consists  of  slow 
moving  Items,  as  illustrated  above,  the  current  financing  of  the 
business  under  survey  must  be  considered  as  being  weak  until 
the  contrary  is  proved  by  other  conditions. 

Consignment  Accounts.— It  is  important  to  ascertain  if 
there  are  any  consignment  accounts  included  among  the  ac- 
counts receivable  or  in  the  inventory  item.  Merchandise  out  on 
consignment  is  not  properly  an  account  receivable  until  the 
merchandise  is  sold  so  that  title  passes  from  the  consignor 
Merchandise  out  on  consignment,  not  being  under  the  direct 
control  of  the  consignor  company,  is  subject  to  incidental  haz- 
ards; therefore,  it  should  be  carried  under  a  separate  classifica- 
tion so  that  the  amount  thereof  may  be  taken  into  considera- 
tion  separately. 

Accrued  Items  As  Current  Assets.— Any  item  representing 
an  accrued  value,  one  not  yet  due  to  be  paid,  is  a  legitimate  cur- 
rent asset  so  far  as  a  group  heading  is  concerned.  Since  it  is 
only  human  nature  for  a  business  man  to  show  all  possible 
asset  Items  upon  his  Balance  Sheet,  but  eliminate  therefrom 
all  possible  liability  items,  one  must  be  most  careful  to  hunt 
for  the  latter  when  criticizing  a  Balance  Sheet.  In  other  words 
as  concerns  the  topic  now  discussed,  one  should  make  sure  that 
the  accnjed  receivable  items  are  not  the  only  class  of  items 
included  upon  the  statement;  liability  items  of  an  accrued  nature 


f 


362 


ADVANCED  ACCOUNTING 


should  be  found  among  the  current  liabilities  if,  among  the  cur- 
rent assets,  there  are  found  asset  items  of  an  accrued  nature. 

Deferred  Charges  As  Current  Assets. — ^These  items  repre- 
sent amounts  which  at  present  are  held  in  suspense  as  assets  even 
though  they  are  actually  expense  items  later  to  be  charged 
against  income.  The  frequent  inclusion  of  these  items  under 
the  general  heading  of  current  assets,  from  a  credit  viewpoint, 
may  be  in  error  in  that  a  portion  of  such  items  may  have  no 
direct  connection  whatsoever  to  the  specific  realization  of  cash. 
In  other  words,  deferred  charges  may  be  grouped  into  two 
classes : 

1.  Those  which  to  some  extent  may  be  realized  in  cash.  A 
value  here  exists  which,  in  the  event  of  insolvency,  may 
be  used  to  liquidate  a  liability.  Such  would  be  the  case  of 
insurance  paid  in  advance. 

2.  Those  which  may  not  be  realized  in  cash.  These  items 
represent  a  heavy  expenditure  during  one  period  which  is 
not  all  consumed  as  an  expense  until  the  next  or  other 
subsequent  periods.  The  value  here  existing  is  uncertain, 
as  least  from  the  Balance  Sheet  point  of  view,  and  con- 
servative practice,  in  the  determination  of  the  value  of  a 
credit  risk,  discourages  considering  such  assets  items  as 
having  any  value  whatsoever. 

Because  of  this  two-way  possibility,  it  is  desirable  to  group 
deferred  charges  under  a  separate  heading  upon  the  Balance 
Sheet  so  that  one  may  not  be  mislead  in  inflating  the  current 
asset  values  by  including  thereunder  items  which  do  not  refer 
to  the  direct  realization  of  cash. 

Miscellaneous  Items  Considered  As  Current  Assets. — 
Securities  consisting  of  bonds,  stocks,  mortgages,  and  other 
commercial  paper  are  good  credit  current  assets  provided  they 
have  a  quick  market  value.  If  they  are  slow,  being  in  the  nature 
of  a  long-time  investment  rather  than  a  temporary  investment, 
they  should  not  be  considered  as  being  current  assets.  The  ap- 
pearance of  this  item  may  indicate  either  a  speculative  tendency 
which  is  undesirable,  or,  it  may  indicate  the  investment  of  sur- 
plus funds  which  is  desirable  and  which  strengthens  credit  stand- 
ing. In  order  to  satisfy  one's  self  as  to  this  point,  it  is  necessary 
to  secure  an  itemized  statement  showing  the  contents  of  this 


STATEMENT  ANALYSIS:  FOR  CREDIT  PURPOSES       363 

asset.  Bonds  or  stocks  of  affiliated  companies  are  not  good 
credit  assets.  The  relationship  existing  between  the  two  con- 
cerns must  be  determined;  one  may  have  contingent  liabilities 
or  contractual  relations  with  the  other  due  to  the  ownership  of 
such  securities. 

Bonds  or  stocks  of  the  issuing  company  may  be  found  among 
the  current  assets: 

1.  Treasury  bonds.  These  are  bonds  which  have  been  author- 
ized and  executed  but  are  held  in  the  company  treasury. 
They  are  not  current  assets  in  any  sense  of  the  word  and 
should  not  be  shown  as  assets  upon  the  Balance  Sheet. 
They  are  analogous  to  signed  promissory  notes  which  have 
not  been  negotiated.  They  should  be  shown  as  a  deduc- 
tion from  the  authorized  bond  issue. 

2.  Unissued  capital  stock.  This  is  not  an  asset  item  from  any 
point  of  view.  The  right  of  a  corporation  to  issue  capital 
stock  is  not  capital;  therefore,  the  debit  offset  thereto,  as 
per  the  ledger,  cannot  be  an  asset. 

3.  Treasury  stock.  This  item  does  not  represent  an  asset, 
only  the  retirement  of  capital  stock  so  far  as  the  outside  is 
concerned.  It  should  be  shown  as  a  deduction  from  the 
capital  stock  authorized. 

Capital  or  Fixed  Assets.— The  relation  of  fixed  assets  to  fixed 
liabilities  is  important  but  of  only  secondary  interest  in  drawing 
a  credit  conclusion.  Large  values  of  these  assets  with  no  notes 
payable  or  other  liability  items  requiring  considerable  fixed 
interest  charges  represent  reserve  financial  strength  which  per- 
mits a  current  stringency  in  current  financing  to  be  relieved 
easily  by  borrowing: 

1.  Actual  borrowing  from  creditors  which  contemplates  the 
payment  of  fixed  interest  charges  plus  the  repayment  of 
principal  at  stated  times. 

2.  Capital  contributions.  The  method  of  securing  funds  by 
this  means  is  superior  to  the  first  one  above  in  that  the  two 
requirements  incidental  thereto,  as  indicated  above,  need 
not  be  considered. 

In  considering  the  item  of  land  and  buildings  (real  estate) 
the  first  point  to  be  covered  is  ownership.    Are  the  properties 


f 


364 


ADVANCED  ACCOUNTING 


» 


i 


owned  in  fee  simple,  or  does  title  rest  with  realty  holding  com- 
panies, individuals,  or  others?  Again,  of  what  construction  are 
the  buildings?  Are  they  in  good  operating  condition  and  well 
adapted  to  the  business,  and  for  other  than  present  use.  Is  a 
suflScient  amount  of  insurance  carried?  Is  there  a  sprinkler 
system  installed?  The  question  of  depreciation  is  decidedly 
important,  especially  where  a  heavy  investment  in  machinery 
is  noticed. 

Mortgages  outstanding  against  such  properties  must  be  given 
attention,  as  well  as  the  amount  of  unpaid  taxes,  special  assess- 
ments, or  other  liens.  Sometimes  statements  show  only  an 
equity  in  real  estate, — ^the  value  of  the  property  less  the  mort- 
gages. This  should  not  be  in  that  the  credit  grantor  should 
know  the  amount  and  maturity  of  the  mortgage  and  the  fixed 
interest  charges.  Further,  there  would  be  no  use  in  presenting 
statements  in  detail  if  as  to  any  one  item  only  net  equity  should 
be  set  out  as  the  only  figure;  if  so,  then  the  entire  Balance  Sheet 
could  be  set  out  as  one  capital  item. 

If  an  increase  in  value  is  noticed,  one  should  determine  if  such 
increase  is  due  to  additions  or  improvements,  or  to  revaluation. 
If  a  steady  increase  in  valuation  is  noticed  from  year  to  year, 
it  is  well  to  know  the  company's  policy  in  this  matter.  Com- 
mercial banks  do  not,  in  general,  condone  the  policy  of  borrowing 
money  to  invest  in  fixed  assets;  it  is  their  feeling  that  new  addi- 
tions, etc.,  should  be  financed  either  out  of  earnings  or  through 
increased  capital  investment. 

Assets  like  good-will,  patents,  trademarks,  leaseholds,  etc., 
are  of  doubtful  value  and  should  either  be  eliminated  entirely 
from  consideration  or  be  given  only  a  mere  nominal  value. 

Although  considerable  space  might  be  used  at  this  point  in 
discussing  certain  things  connected  with  fixed  assets  in  relation 
to  a  credit  risk,  other  than  the  above,  these  cursory  remarks  are 
deemed  sufficient  in  that  these  separate  items  must  be  discussed 
in  detail  in  the  next  chapter  in  connection  with  Balance  Sheet 
analysis  from  an  investment  point  of  view. 

Liability  Analysis— In  General.— As  each  asset  item  is 
examined,  it  would  be  well  to  look  for  and  set  up  the  liabilities 
which  are  not  shown.  If  a  Balance  Sheet  carries  the  audit  cer- 
tificate of  a  competent  accountant,  the  credit  examiner  should 


STATEMENT  ANALYSIS:  FOR  CREDIT  PURPOSES       365 

consider  this  as  a  most  valuable  safeguard  against  omissions  of 
this  character  due  to  mistake  or  fraud. 

If  the  Balance  Sheet  lacks  such  a  certificate,  inquiry  concem- 
mg  the  possible  omissions  of  liabilities  should  proceed  along  the 
following  lines: 

1.  Purchases  on  credit  may  be  represented  in  the  inventories 
but  not  be  offset  on  the  books  of  account  by  the  proper 
credit  entries  thereon.  The  liabilities  offsetting  such  pur- 
chases must  be  paid  long  before  the  asset  represented  by 
the  inventory  figures  can  be  realized  in  cash. 

2.  Payroll  accrued. 

3.  Interest  accrued. 

4.  Etc. 

Notes  or  Bills  Payable.— These  should  be  only  either  for 
merchandise  or  for  money  borrowed.  When  the  proportion  is 
high,  the  Item  is  important.  If  a  concern  purchases  on  account, 
the  notes  payable  covering  purchases  should  be  small,  at  most' 
A  merchant  should  not  at  the  same  time  give  notes  for  mer- 
chandise, and  borrow  upon  his  single  name  paper;  the  latter 
normally,  is  supposed  to  permit  him  to  pay  cash  and  take  dis- 
counts. The  notes  payable  should  be  segregated  into  the  classes 
thereof  as  has  already  been  indicated  previously. 

Odd  cents  in  the  notes  payable  item  should  put  the  loaner  on 
his  inquiry;  it  may  indicate  that  notes  have  been  given  for 
merchandise.  The  reason  may  be  otherwise,  however,  as  the 
odd  cents  may  be  due  to  the  subtraction  of  interest  unearned 
from  face  values,  the  latter  being  in  round  sums.  If  a  renewal 
policy  exists,  the  concern's  credit  and  general  business  condition 
will  determine  if  the  note  liabilities  are  able  to  be  continued  or 
will  have  to  be  taken  up  at  once  from  current  funds.  The  con- 
tingent liability  on  notes  receivable  discounted  should  be 
determined. 

Accounts  Payable.— This  item  should  not  be  large  if  the 
notes  payable  be  of  considerable  size,  and  vice  versa.  They 
should  represent  recent  purchases.  Inquiry  should  be  made  to 
ascertain  if  any  collateral  has  been  given  to  protect  any  of  the 
payable  items,  since  this  would  prejudice  creditors.  Inquiry 
should  be  made,  also,  to  determine  whether  the  greater  portion 
of  the  accounts  payable  is  due  to  one  concern  or  are  scattered 


1 


'It 


I   . 


366 


ADVANCED  ACCOUNTING 


well.  If  the  former  condition  is  in  evidence,  one  should  ascer- 
tain if  there  be  any  chance  of  credit  relations  being  severed  in 
the  near  future  with  the  business  with  which  credit  is  localised; 
should  this  occur,  disaster  may  come  quickly.  An  analysis  of 
the  accounts  payable  as  under: 

1.  Accounts  less  than  thirty  days  past  due, 

2.  Accounts  from  thirty  to  sixty  days  past  due, 

3.  Accounts  from  sixty  to  ninety  days  past  due, 

4.  Accounts  ninety  days  or  more  past  due, 

will  indicate  whether  the  concern  is  falling  behind  in  liqui- 
dating its  accounts  payable. 

Capital  or  Fixed  Liabilities. — ^Any  liability  which  falls  due 
within  ninety  days  may  well  be  classed  as  a  current  liability  from 
the  standpoint  of  credit  granting.  Therefore,  in  analyzing  the 
capital  liabilities,  the  analyst  should  determine  if  any  of  them 
are  going  to  fall  due  in  the  near  future,  and  if  they  will  require 
payment  at  such  time.  Mortgages,  bonds,  etc.,  should  show  due 
dates  and,  if  these  due  dates  are  current,  one  should  make  sure 
that  adequate  means  are  provided  to  pay  or  renew. 

If  any  of  these  fixed  liabilities  will  fall  due  in  the  near  future, 
they  are  no  longer  fixed  in  character;  they  are  decidedly  of  a 
current  nature,  unless  provision  has  been  made  for  renewal. 
When  payment  is  made,  the  cash  fund  must  be  depleted  there- 
under in  exactly  the  same  manner  as  if  these  liabilities  were  of 
the  ordinary  current  kind.  In  this  particular,  at  least,  a  credit 
Balance  Sheet  must  differ  as  to  arrangement  of  items  from  the 
Balance  Sheet  of  the  ordinary  kind. 

The  proprietorship  element  should  not  be  too  small  as  com- 
pared to  all  debts  to  outsiders.  Bonded  debt,  in  a  sense,  is 
intermediate,  bondholders  being,  from  one  point  of  view,  lenders 
and,  from  another  point  of  view,  often  proprietors. 

The  Comparative  Balance  Sheet. — This  statement  is  most 
useful  in  bringing  to  light  either  inaccuracies  or  fraud  in  setting 
out  the  financial  condition  of  an  enterprise.  By  its  use,  items 
may  be  compared  one  with  another  to  the  end  that: 

1.  Important  changes  in  condition  will  be  disclosed. 

2.  An  intelligible  basis  is  secured  by  means  of  which  the  right 
kind  of  questions  may  be  asked  looking  toward  the  dis- 
covery of  important  information. 


STATEMENT  ANALYSIS:  FOR  CREDIT  PURPOSES       367 

Again,  where  a  Statement  of  Profit  and  Loss  has  not  been 
submitted,  the  profit  or  loss  of  the  period  just  passed,  as  of  the 
end  of  which  the  Balance  Sheet  has  been  prepared,  may  be  deter- 
mined by  a  comparison  of  Balance  Sheets  provided  the  drawings 
or  dividend  distributions  of  the  past  period  are  known. 

In  preparing  the  Comparative  Balance  Sheet  for  present  pur- 
poses, one  might  do  well  to  proceed  about  as  follows: 

1.  Take  a  sheet  of  analysis  paper  and  list  thereon  by  years 
the  assets  and  liabilities  as  shown  by  the  Balance  Sheets 
submitted : 

a.  List  the  current  assets  first  and  show  total. 

b.  List  the  current  liabilities  directly  thereunder  and  dis- 
play total. 

c.  Deduct  the  total  of  (b)  from  the  total  of  (a),  and  bring 
down  the  resulting  balance  into  the  same  column.  This 
balance  represents  working  capital. 

d.  List  the  capital  assets  in  the  same  column  and  show  total. 

e.  List  the  capital  liabilities  directly  thereunder  and  display 
total. 

f.  Deduct  the  total  of  (e)  from  the  total  of  (d),  and  show 
resulting  balance. 

g.  Add  (c)  and  (f)  and  show  total.  This  represents  the 
amount  of  net  capital  available  for  permanent  purposes. 

h.  List  outstanding  capital  stock  and  the  credit  balances  of 

any  undistributed  profits  accounts,  such  as  surplus  and 

reserves,  and  secure  total.    This  total  should  agree  in 

amount  with  the  accounting  capital  as  shown  at  (g). 

The  comparative  statement  prepared  as  above,  each  succeeding 

year  bemg  in  the  column  to  the  right  of  the  preceding  one,  will 

enable  a  person  to  note  quickly: 

1.  The  relative  importance  or  weight  of  individual  items. 

2.  The  fluctuations  in  working  capital. 

3.  The  net  capital  available  for  permanent  purposes. 

Again,  such  a  statement  will  enable  the  credit  analyst  to  calcu- 
late with  ease  increases  and  decreases  from  year  to  year.  Too 
much  emphasis  cannot  be  placed  upon  following  a  logical  pro- 
cedure  such  as  has  been  indicated  above  rather  than  to  work 
in  a  hit  or  miss  fashion  when  analyzing  statements  for  credit 
purposes.    A  definite  plan  of  attack  closes  most,  if  not  all,  of  the 


368 


ADVANCED  ACCOUNTING 


possible  avenues  looking  toward  misrepresentation  and  renders 
available  for  future  reference  the  important  results  that  have 
been  deduced;  the  haphazard  approach  does  not  promote  this 
efficiency  and  is  to  be  deplored. 

The  Statement  of  Fund  Application. — As  an  outgrowth  of 
the  Comparative  Balance  Sheet,  the  better  to  present  the  infor- 
mation therefrom  obtained,  the  Statement  of  Fund  Application  is 
useful  and  valuable.  However,  the  discussion  of  this  statement 
is  postponed  until  near  the  end  of  the  next  chapter  the  better  to 
equalize  the  contents  of  these  present  two  chapters. 

The  Income  Statement. — ^Although  this  statement  is  exceed- 
ingly important,  it  is  usually  lacking.  The  loaner  of  short-term 
credit  desires  to  see  not  assets  alone, — ^the  brick  and  mortar, — 
but  earning  power  as  well,  with  money  coming  in  steadily  enough 
both  to  meet  his  note  and  other  just  current  claims.  Net  earnings 
are  important  in  this  connection,  as  property  is  to  be  valued 
chiefly  as  a  means  of  earning;  i.  e.,  according  to  its  activity,  and 
not  merely  something  that  may  be  put  under  the  hammer,  with 
losses,  perhaps,  all  around. 

An  income  statement  should  show  gross  sales,  cost  of  goods 
sold  (including  cost  of  manufacture,  if  any),  and  resultant  gross 
profits,  deductions  of  expense,  including  all  charges,  such  as  de- 
preciation, repairs,  etc.,  and  the  resultant  net  profits  from  opera- 
tion; to  this  any  outside  income  would  be  added  and  any  finan- 
cial expense  subtracted. 

When  this  statement  is  lacking,  the  profit  and  loss  outcome 
may  be  determined  from  the  Comparative  Balance  Sheet,  as  has 
been  indicated  above. 


CHAPTER  XI 

STATEMENT  ANALYSIS  (continued) :  FOR 
INVESTMENT  PURPOSES 

Introduction.-In  the  last  chapter,  certain  principles  were 
presented  on  analyzing  a  statement  for  credit  purposes.  In  the 
present  chapter,  statement  analysis  is  discussed  further,  this 
time  primarily  from  the  viewpoint  of  an  investor.  Investment 
contemplates  placing  funds  so  that  the  principal  will  be  safe 
and  an  mterest  return  be  assured.    On  the  other  hand,  specula- 

Zr'^  T  ^^"""^  "'  "°  '^intelligent  attempt  to  discount  the 
tuture.  In  order  to  bring  the  present  discussion  within  the 
confines  of  one  chapter,  the  attention  will  be  concentrated  only 
upon  the  mdustrial  enterprise,  excluding  all  others,  this  classi- 
fica  ion  comprehending  those  engaged  in  manufacturing,  dis- 
tribution  and  trading,  and  construction. 

It  is  remarkable  how  persons,  in  general,  who  have  labored 
years  m  accumulating  funds,  will  place  part,  if  not  all,  of  these 
funds  m  various  types  of  investments  after  only  a  fe^  minuSs 
of  cursory  deliberation.  Because  of  this  fact,  whether  the  ge^! 
eral  market  appears  good  or  bad,  many  securities  are  for  sale 
wh.ch  are  entirely  out  of  line  therewith,  whose  entire  founda- 

nrn.     7  1    ''  '  T'  ^^"^^i^^tio^  and  whose  flotation  de- 
pends  entirely  upon  the  cupidity  of  human  nature 

If  investors,  and  even  speculators,  would  base  their  decision 

and  Inl  '        T""  "''''^^'  '''^'^  ^^^^  ^^^^^^1'  deliberate 

and  cool  analysis,  the  security  markets  would  assume  soon  a 

character  entirely  different  than  they  have  at  preset 

Large  Versus  Small  Scale  Enterprises.-Present  economic 

life  leans  toward  specialization,  the  elimination  of  waste  at  aH 

possible  points     Therefore,  the  large  scale  enterprise  is  a  neces 

sity,  Its  advantages  being  about  as  follows- 

1.  Ease  in  financing.    From  the  financier's  point  of  view  the 

small  corporation  is  useless;  its  securities  cannot  be  handled 

except  for  an  exorbitant  charge.  "<*naiea 

369 


370 


ADVANCED  ACCOUNTING 


2.  Location.  Because  of  its  financial  strength  the  large  cor- 
poration may  choose  its  location  as  seems  best,  consistent 
with  its  market  and  source  of  raw  material.  The  small 
corporation,  too  often,  like  Topsy  "just  growed,"  so  far  as 
locality  is  concerned.  Even  the  best  of  small  companies 
will  suffer  in  competition  with  a  corporation  which  has 
plants  and  distributing  agencies  in  all  parts  of  the  country. 
A  corporation  operating  only  in  one  community  will  dis- 
cover sooner  or  later  that  business  is  influenced  more  by 
local  conditions  than  by  those  of  national  import. 

3.  Advertising.  National  advertising  campaigns  can  be  con- 
ducted by  the  large  corporation,  whereas,  the  small  one, 
usually,  is  prohibited  therefrom. 

4.  Improved  and  economical  production  methods.  Large 
plants  can  take  advantage  of  any  discovery  of  an  improve- 
ment in  production  processes  tending  either  toward  econ- 
omy or  increase  in  output. 

5.  Purchasing  in  large  quantities  results  in  a  lower  cost. 
Only  large  scale  production  and  distribution  will  permit 

of  this. 

6.  The  highest  priced  brains  can  be  hired,  without  dependence 
in  manufacturing  and  distribution  resting  upon  the  life  or 
ability  of  any  one  individual.  Each  part  of  the  organiaa- 
tion  is  given  the  advantages  of  the  best  practices  of  the 
others.  Experimental  and  development  work  may  be  car- 
ried on  extensively  even  though  the  cost  be  high. 

7.  Foreign  trade  may  be  developed  beyond  the  point  of  great- 
est expectation  of  any  small  company. 

8.  Waste  or  by-products  may  be  utilized  to  the  best  advantage 
in  that  large  scale  production  will  produce  great  quantities 
thereof  to  become  the  basis  of  a  side-line  endeavor. 

9.  Fire,  flood,  or  strikes  will  not  be  apt  to  cripple  a  corpora- 
tion having  several  plants. 

10.  A  great  variety  of  articles  may  be  produced  in  many  large 
industrial  concerns  to  the  end  that  the  average  demand  will 
be  more  dependable,  usually,  than  where  a  company  pro- 
duces only  one  article  or  a  limited  number  of  articles. 
General  Factors  of  Investment  Importance.— Before  pass- 
ing on  to  a  discussion  of  the  specific  factors  involved  in  state- 


STATEMENT  ANALYSIS:  FOR  INVESTMENT  PURPOSES    371 

ment  analysis  upon  which  an  intelligent  investment  or  specula- 
tion may  be  made,  certain  general  factors  may  be  mentioned 
which,  although  not  securable  from  a  statement  scrutiny  alone, 
nevertheless,  are  of  marked  import.  These  general  factors  are 
commented  upon  below  in  a  summary  manner: 

1.  Demand.  Even  though  the  industrial  corporation,  in  gen- 
eral, has  had  no  cause  to  promote  a  pessimistic  attitude  as 
to  the  amount  of  business  done,  fluctuations  in  demand  will 
occur  and  may  cause  serious  results.  Therefore,  certain 
questions  pertaining  to  demand  should  be  considered  care- 
fully and  be  answered  satisfactorily.  Needless  to  say,  the 
good  industrial  proposition,  when  investigated,  will  permit 
these  questions  to  be  answered  in  the  afiirmative: 

a.  Will  sales  continue  and  expand  consistently? 

b.  Does  the  business  deal  in  a  necessity?  If  it  manufac- 
tures what  may  be  classed  as  a  luxury,  one  should  be 
careful. 

c.  Are  sales  made  in  large  volume  at  a  small  profit? 

d.  Is  the  business  a  steady  one?  Seasonal  fluctuations  are 
apt  to  be  disastrous. 

e.  Is  style  or  fad  eliminated  in  controlling  gross  receipts? 
2.  Diversification.     The  more  diversified  the  activities  of  an 

industrial  enterprise,  the  greater  will  be  the  opportunity 
to  succeed.  If  sales  are  dependent  upon  one,  or  a  few 
articles,  a  sharp  drop  in  demand  may  spell  disaster.  Enter- 
prising concerns  are  feeling  out  the  market  all  the  time, 
ascertaining  how  long  it  will  last,  its  greatest  possibilities,' 
and  what  portion  thereof  can  be  taken  care  of  keeping  in 
mind  other  competitors;  this  information  costs  money  to 
secure  and  only  the  larger  companies  can  afford  the  price 
of  such  investigations.  A  diversified  business  is  depend- 
able; unforeseen  circumstances  count  for  naught,  as  time 
and  effort  have  provided  there  against;  in  a  period  of  de- 
pression, foresight  will  have  provided  for  pushing  some- 
thing other  than  the  standard  article,  perhaps  something 
entirely  new. 

3.  Integration.  Great  importance  may  or  may  not  be  attached 
to  the  control  over  permanently  adequate  sources  of  raw 
material;  in  some  industries  it  is  a  most  serious  question 


372 


ADVANCED  ACCOUNTING 


whereas,  in  others,  the  seriousness  is  not  so  pronounced. 
Consider  the  following  possibilities: 

a.  Industries  controlling  raw  materials  in  all  stages  of 
manufacture  have  a  tremendous  advantage  during  times 
when  the  cost  of  raw  material  is  high.  When  this  prac- 
tice is  followed,  however,  care  must  be  observed  not  to 
have  too  much  capital  tied  up  therein;  by  so  doing,  the 
industrial  becomes  raw  material  poor. 

b.  If  an  industry  can  make  favorable  arrangemtmts  for 
securing  raw  materials  as  needed,  the  advantages  of 
integration  are  unnecessary,  because  the  control  of  raw 
materials  is  not  indispensable. 

c.  Certain  industries  may  find  it  impracticable  to  own  or 
operate  sources  of  raw  materials,  as  a  cotton  mill,  or 
a  stock  yard. 

d.  It  is  impossible  for  some  industries  to  control  raw  ma- 
terial sources  even  if  they  desired  to  do  so;  the  nature 
of  the  work  done  would  be  prohibitive.  A  detinning 
company  cannot  obtain  unlimited  quantities  of  scrap  tin 
from  any  one  company. 

e.  Some  concerns  combine  their  interests  with  others  of 
a  related  nature  in  order  to  secure  a  type  of  integration, 
as  well  as  a  reconciliation  of  existing  contract  interests. 
A  copper  company  producing  sulphuric  acid  may  combine 
with  a  chemical  company. 

4.  Competition.  As  competition  grows  keener  with  the  in- 
crease in  manufacturing,  the  profits  per  dollar  of  gross 
sales  will  grow  smaller;  large  profits  invite  competition, 
and  competition  destroys  large  profits. 

5.  Dividend  policy.  Comparatively  few  people  have  a  suffi- 
cient breadth  of  vision  to  be  willing  to  postpone  an  im- 
mediate pleasiu-e  for  the  sake  of  greater  future  enjoyment. 
Haste  in  declaring  dividends  often  has  proved  disastrous. 
The  credit  of  a  corporation  cannot  be  maintained  by  the 
declaration  of  unearned  dividends.  To  the  unsophisticated, 
dividends  give  the  appearance  of  prosperity,  but  the  trained 
analyst  never  should  be  guilty  of  making  this  mistake. 
Diligent  attention  to  business  coupled  with  the  wise  rein- 
vestment of  surplus  earnings  have  been  the  means  of  plac- 


STATEMENT  ANALYSIS:  FOR  INVESTMENT  PURPOSES    373 

ing  some  of  the  great  industrials  in  the  enviable  position 
they  occupy  to-day.  The  long-range  financial  policy  look- 
mg  toward  the  conservation  of  earnings  until  stable  divi- 
dends can  be  paid  is  more  to  be  desired  than  the  policy 
swayed  by  the  babble  of  the  mob. 

6.  Financial  alliances.  The  right  management  whether  or  not 
by  itself  financially  strong  will  command  financial  backing 
and,  m  turn,  financial  backing,  if  of  sufficient  strength  will 
carry  through  a  corporation  that,  otherwise,  would 'suc- 
cumb. A  number  of  companies  are  economic  failures,  not 
earnmg  a  fair  interest  return  upon  the  capital  risks  in- 
volved, but  still  they  are  decidedly  alive  because  of  strong 
control  and  financial  alliances. 

7.  Industrial  relations.  Freedom  from  labor  troubles  is  one 
of  the  most  important  elements  looking  toward  the  success 
of  an  mdustrial  enterprise.  A  corporation  should  be  gen- 
erous with  its  producers  of  business,-its  workers;  welfare 
work  and  profit-sharing  are  not  only  creditable  but  are 
business  necessities.  In  judging  of  industrial  securities 
trom  this  angle,  one  should  ascertain  satisfactorily 

a.  Whether  the  company  has  the  enthusiastic  loyalty  of  its 
directors,  officers,  and  employees. 

b.  Whether  the  corporation  shares  its  profits  with  its  em- 
ployees,  or  offers  its  securities  to  them  on  attractive 
terms  so  that  they  may  become  partners  in  the  business 

8.  Personnel  management.   The  ability  of  corporate  managers 
to  increase  sales,  to  lower  costs,  to  improve  the  quality  of 
the  product  to  direct  policies,  and  to  master  the  financial 
problems  of  the  industries  with  which  they  are  connected 
constitutes  an  important  element  in  maintaining  the  stand- 
ing of  their  securities;  this,  in  turn,  is  dependent  upon  the 
personal   equation.     Corporate   managers   should   be   pre- 
pared for  depression  in  times  of  prosperity;  if  they  are 
rr;?  7.'"^'  times  of  great  prosperity,  one  should 
be  careful  of  looking  with   favor  upon  the  securities  of 
the  companies  these  managers  represent.    Again,  if  a  com- 
pany has  been  recapitalized  recently,  it  is  of  prime  im- 
portance to  know  whether  the  management  will   remain 
the  same  as  that  which  was  responsible  for  the  company's 


374 


ADVANCED  ACCOUNTING 


1 1 


success  in  the  past,  assuming  the  old  management  to  con- 
sist of  large  caliber  men.    Many  concerns  have  failed  as  a 
result  of  the  retirement  of  its  founders. 
Publicity  Through  Published  Statements. — Investment  or 
speculation  is  not  intelligently  possible  without  there  being  at 
hand  complete  and  frequent  reports  on  earnings  and  reliable 
statements  on  financial  condition,  concerning  the  enterprise  un- 
der consideration.     If  an  industrial  enterprise  does  not  issue 
reliable  and   frequent   information  of  the   character  indicated 
above,  one  should  not  be  interested  therein.    Also,  information 
should  be  available  to  the  effect  that  the  management  has  the 
benefit  of  the  stockholders,  as  a  whole,  in  mind.     Continued 
publicity  and  conscientious  responsibility  are  all  important  if 
an  industrial  proposition  is  to  be  considered  at  all  as  an  invest- 
ment. 

If  a  corporation  has  its  stock  listed  on  the  New  York  Stock 
Exchange,  it  is  required  to  publish  at  least  once  a  year  an  in- 
come statement  and  a  Balance  Sheet  (consolidated,  if  the  enter- 
prise requires  such).  These  statements  must  be  published  so 
that  they  will  be  in  the  hands  of  the  stockholders  at  least  fifteen 
days  in  advance  of  the  annual  meeting.  It  is  desired,  also,  that 
quarterly  or  semi-annual  reports  be  published  in  addition  to 
the  compulsory  annual  report;  quarterly  reports  of  earnings  are 
much  to  be  desired,  and  no  reason  exists,  in  general,  for  not 
having  them  prepared.  If  done,  the  stockholders  will  not  be 
at  the  disadvantage  in  which  they  so  often  find  themselves  as 
compared  with  the  company  management,  who  are  on  the  inside, 
as  where  reports  come  through  only  once  a  year. 

Nearly  all  large  corporations  publish  annual  reports  which 
are  available  upon  request  to  the  secretary.  But  since  there 
exists  a  lack  of  uniformity  in  the  requirements  of  present-day 
industrial  accounting,  many  of  these  corporate  statements  are 
noteworthy  for  what  they  omit  rather  than  for  the  informa- 
tion that  may  be  secured  from  a  study  thereof. 

In  prosperous  times.  Balance  Sheets  are  apt  to  be  conserva- 
tive. Hidden  assets  often  are  created  through  unwarranted  re- 
serves for  depreciation  and  by  the  acquirement  of  property  out 
of  surplus  earnings  which  does  not  appear  upon  the  Balance 
Sheets.    On  the  other  hand,  in  times  of  adversity,  corporate  re- 


STATEMENT  ANALYSIS:  FOR  INVESTMENT  PURPOSES    375 

ports  often  must  be  viewed  with  skepticism.  As  earnings  be- 
come impaired,  managers  are  inclined  to  skimp  depreciation, 
maintenance,  and  reserves  in  order  to  make  a  creditable  showing.' 
Therefore,  with  the  customary  sequence  of  prosperity  and  de- 
pression, the  interpretation  of  corporate  statements  usually  must 
include  a  consideration  of  general  business  conditions  plus  the 
lack  of  uniformity  in  statement  set-up  and  content. 

Fire  Insurance  and  Corporate  Assets.— One  important  fac- 
tor apt  to  be  overlooked  in  analyzing  corporate  reports  relates 
to  fire  msurance.  In  analyzing  the  Balance  Sheet  assets,  one 
should  ask  himself  the  following  pertinent  questions  and  make 
certam  the  answers  thereto  are  entirely  satisfactory: 

1.  Is  there  any  element  underlying  the  case  that  is  of  more 
import  than  adequate  fire  insurance  being  in  force? 

2.  If  not,  is  there  sufficient  insurance  in  force? 

3.  Does  the  amount  of  insurance  cover  adequately  fluctuations 
m  values? 

4.  What  would  be  the  effect  of  a  serious  fire  upon  the  se- 
curities concerning  which  an  interest  is  manifested? 

.u^lf^^."''  ^^^'^^^  Assets.-Balance  Sheet  valuations  covering 
the  fixed  or  capital  assets  often  are  largely  fictitious;  in  fact 
arbitrary  figures  frequently  are  set  down  upon  the  left  side  of 
the  Balance  Sheet  in  such  amounts  as  will  offset  the  actual 
amount  of  outstanding  stocks  and  bonds  found  listed  on  the 
right  side.    The  overvaluation  of  obsolete  fixed  assets,-plant 
machinery,  and  equipment,-has  caused  the  wreck  of  many  a 
promising  business.     Inflated  valuations  baffle  successful  ana- 
ysis  looking  toward  the  determination  of  the  real  asset  value 
the  amount  of  "water"  therein  contained,  and  whether  or  not 
the  proper  amount  of  depreciation /is  being  charged  regularly 
against  earnings.  '  »        j 

The  discussion  concerning  specific   fixed  or   capital   assets 
separates  these  assets  into  two  groupings: 

1.  Immovable  fixed  assets.     These  assets  represent  the  real 
property  elements. 

2.  Movable  fixed  assets.    These  assets  represent  the  personal 
property  elements. 

Land.— Real  property  consists  of  land  and  buildings.     Fre- 
quently, these  two  items  are  combined  under  the  caption  of  "real 


tm 


376 


ADVANCED  ACCOUNTING 


estate."  The  two  items  should  be  listed  separately  upon  the 
Balance  Sheet  if  a  proper  interpretation  thereof  is  to  be  pos- 
sible. Land,  as  a  fixed  asset,  in  general,  is  subject  neither  to 
depreciation  nor  to  appreciation;  buildings,  on  the  other  hand, 
are  depreciating  constantly.  Again,  the  separation  of  the  two 
items  or  values  is  essential  for  insurance  purposes,  and  for  the 
proper  adjustment  of  fire  losses  should  such  losses  occur. 

Since  land  may  consist  of  various  it'^ms,  the  Balance  Sheet 
figures  thereof  should  be  supported  by  full  explanatorv  detail 
together  with  proper  reference  to  documents  supporting  the 
analysis  of  the  various  items  and  the  legitimacy  of  tlieir  ex- 
istence. Full  cost,  with  neither  depreciation  nor  appn^ciation, 
is  the  valuation  formula  for  land.  Full  cost  contemplates  com- 
plete cost  in  condition  ready  for  use  or,  at  least,  up  to  full  title 

date. 

Since  the  purchase  contract  price,  attorney's  fees,  broker's 
commissions,  or  a  fair  portion  of  the  purchasing  agent's  salary, 
the  costs  of  search  and  title  guarantee  (if  these  be  borne  by 
purchaser),  notarial  and  recording  fees,  assumption  of  taxes 
owing  at  date  of  purchase,  local  improvement  taxes  and  assess- 
ments (for  sewer,  water  mains,  curbing,  paving),  and  costs  of 
leveling,  grading,  filling  and  draining,  are  all  legitimate  charges 
enhancing  the  cost  of  land,  the  greatest  care  must  be  observed 
by  the  analyst  in  his  scrutiny  of  the  land  item  not  to  permit 
too  many  of  these  additional  charges  to  be  capitalized  beyond 
reason  because,  thereby  the  land  value  may  be  inflated  greatly, 
although  not  apparently  so ;  inflations,  particularly  those  on  real 
property,  are  detrimental. 

Buildings. — ^When  buildings  are  erected  by  the  concern  itself, 
full  cost  may  include  not  only  the  cost  of  materials  and  labor, 
plus  a  fair  portion  of  the  establishment  overhead  where  super- 
vision of  construction  is  local,  but  all  other  expenses  incurred 
directly  in  connection  with  construction.  These  latter  expenses 
may  include  such  items  as  architect's  fees,  for  plans  and  super- 
vision, costs  of  permits  and  licenses,  interest  on  borrowed  money 
and  insurance  during  the  construction  period,  costs  of  accidents 
and  injuries  to  workmen  during  construction,  costs  of  easements, 
damages,  and  strike  costs.  Again,  in  this  connection,  the  great- 
est care  must  be  observed  by  the  analyst  in  his  scrutiny  of  the 


STATEMENT  ANALYSIS:  FOR  INVESTMENT  PURPOSES    377 

buildings  item  to  make  sure  the  value  thereof  has  not  been 
greatly  inflated. 

The  valuation  formula  for  buildings  is  full  cost  less  deprecia- 
tion. Where  a  number  of  buildings  exist,  a  subsidiary  building 
record  is  of  value  to  show  the  separate  cost  of  each  item,  and 
from  this  the  total  value  is  determined.  Such  a  record  plus  a 
map  showing  location  of  properties,  is  valuable  in  case  of  fire 
loss. 

In  determining  the  depreciation  of  buildings,  many  things 
must  be  considered  carefully.  Not  only  must  the  depreciation  of 
use,— wear,  tear,  and  lapse  of  time,— be  studied,  but  the  factors 
of  obsolescence  and  inadequacy  must  not  be  forgotten  since  they 
shorten  the  service  life  of  the  structures. 

Depreciation  rates  for  buildings,  according  to  different  au- 
thorities, cover  a  wide  range.  While  some  authoritative  rates 
are  available,  no  standard  rates,  unless  compulsory,  should  be 
used  without  a  careful  study  being  made  of  local  conditions. 

Structures  of  a  temporary  nature  should  be  charged  at  net 
cost  (fuH  cost  less  salvage  value)  against  the  product  or  the  job 
for  which  they  have  been  erected.  Buildings  owned  as  a  free- 
hold for  life  (a  life  interest  in  buildings)  are  not  subject  to 
depreciation,  because  the  remainderman  takes  the  building  over 
in  its  condition  as  released  by  the  party  owning  the  life  in- 
terest. 

Machinery  and  Machine  Tools.— The  movable  fixed  assets 
are  next  to  be  considered.  In  general,  these  consist  of  those 
assets  which  are  comprehended  by  the  term  ''equipment,"  such 
as  machinery  and  tools,  furniture  and  fixtures,  delivery  equip- 
ment, patterns,  lasts,  dies,  maps,  drawings,  electrotypes,  ovens, 
furnaces,  etc.  The  valuation  of  these  items  presents  nothing 
new  in  principle,  although  many  points  relative  to  the  applica- 
tion of  the  principles  are  important. 

Machinery  and  tools,  as  an  asset  caption,  include  not  only  the 
assets  ordinarily  carried  upon  the  ledger  under  the  account  of 
that  name,  but  power  machinery,  power  transmission,  shafting, 
connections,  electric  transmission  cables,  and  the  like.  The 
factor  of  depreciation  is  of  marked  import  in  the  valuation  of 
this  asset.  It  is  readily  apparent  that  not  only  do  the  various 
pieces  of  machinery  differ  in  the  amount  of  depreciation  thereon 


378 


ADVANCED  ACCOUNTING 


within  the  same  plant,  but  the  same  machines  used  in  different 
plants  will  vary  in  the  amount  of  depreciation  thereon;  even  in 
the  same  factory  two  similar  machines  will  not  usually  de- 
preciate to  the  same  amount  in  the  same  period  of  time. 

Every  machine  and  machine  tool  should  be  charged  with  its 
full  cost,  and  should  be  valued  at  full  cost  less  depreciation. 
Full  cost  is  understood  to  include  such  items  as  invoice  price, 
insurance  during  transit,  freight,  duty,  drayage,  and  installation 
charges.  In  analyzing  this  asset,  one  should  investigate  thor- 
oughly the  method  of  valuation ;  one  should  look  with  skepticism 
upon  unreasonable  figures.  Exercise  care  in  eliminating  from 
the  account  all  intangible  values  such  as  the  cost  of  rearranging 
the  machinery  upon  the  floor,  as  a  general  proposition. 

Furniture  and  Fixtures. — The  items  included  under  this 
account  may  consist  of  the  usual  tables,  desks,  filing  cabinets, 
book  cases,  typewriters,  safes,  chairs,  counters,  and  the  more 
unusual  items  of  plumbing  fixtures,  show  windows,  partitions, 
shelving,  etc.  The  asset  may  be  valued  either  on  the  basis  of 
cost  less  estimated  depreciation  or  on  the  inventory  basis.  In 
using  the  depreciation  account  in  connection  with  the  first 
method  of  valuation,  one  should  remember  that  the  asset  usually 
has  but  small,  if  any,  residual  or  scrap  value;  scrap  value  in 
some  cases  is  the  value  the  asset  has  as  kindling  wood.  Where 
a  depreciation  rate  is  \ised  by  means  of  which  to  determine  the 
value  of  this  asset,  the  rate  should  be  exceedingly  liberal. 

When  premises  are  leased  and  the  terms  of  the  lease  require 
certain  of  the  equipment  to  remain  with  the  building  after  the 
lease  expires,  care  must  be  observed  to  write  off  completely  the 
items  covered  by  the  end  of  the  lease  period. 

On  the  whole,  this  account  contains  a  value  which  is  more  or 
less  inflated,  to  the  end  that  the  wide-awake  analyst  always 
will  discount  to  a  marked  degree  the  value  shown  under  this 
caption. 

Delivery  Equipment. — This  item  includes  all  property,  direct 
or  auxiliary,  used  in  connection  with  the  delivery  of  goods  both 
inward  and  outward.  Horses,  wagons,  harness,  motor  trucks  and 
cars,  containers,  etc.,  are  familiar  examples  of  this  class  of  asset. 
In  general,  these  assets  are  handled  very  much  as  are  all  the 
others  of  the  equipment  group.    For  the  most  part,  valuation  is 


STATEMENT  ANALYSIS:  FOR  INVESTMENT  PJJRPOSES    379 

on  the  basis  of  cost  less  depreciation,  but  well  may  be  by  the 
application  of  the  inventory  method. 

Where  horses  comprise  a  portion  of  the  equipment,  not  only 
must  depreciation  due  to  wear  and  tear  be  reckoned,  but  the 
possibilities  of  accident,  such  as  death  and  disablement,  must  be 
given  consideration.  Experience  in  each  business,  based  upon 
the  particular  kind  of  work  to  be  performed,  and  the  conditions 
under  which  it  is  being  performed,  furnishes  the  only  adequate 
basis  of  valuation. 

Drawings,  Models,  Patterns,  Etc.— Items  such  as  patterns, 
lasts,  molds,  dies,  drawings,  electrotypes,  wood  cuts,  forms, 
models,  etc.,  comprising  the  last  of  the  equipment  assets  to  be 
considered,  whenever  possible,  should  be  charged  to  the  par- 
ticular job  for  which  they  were  made  and  should  not  be  carried 
on  the  Balance  Sheet  as  an  asset.  Naturally,  this  is  not  often 
possible  since  these  items  frequently  can  be  used  for  successive 
production.  At  best,  however,  they  are  a  treacherous  and 
highly  speculative  asset  requiring  the  greatest  of  care  in  order 
not  to  be  carried  at  an  inflated  value. 

Valuation  should  be  on  the  basis  of  cost  with  a  liberal  de- 
preciation running,  at  times,  to  50,  or  even  a  higher,  per  cent. 
Again,  valuation  may  be  on  the  inventory  basis.  In  general, 
whatever  the  method  of  valuation,  one  cannot  be  too  ruthless  in 
scaling  the  given  valuation  down  to  the  lowest  possible  point. 

Good-will.— This  item  often  represents  a  baffling  obstruction 
to  the  clear  analysis  of  a  corporate  report  in  that  it  is  merged 
upon  the  Balance  Sheet  repeatedly  with  the  plant  or  property 
account.  Arbitrarily,  the  intangible  asset  of  good-will,  repre- 
senting supposedly  the  capitalization  of  profits  from  business 
secured,  may  be  carried  upon  the  Balance  Sheet  at  any  amount 
whatever.  In  fact,  such  an  account  as  "plant,  good-will,  etc.," 
usually  may  be  considered  as  consisting  mostly,  if  not  entirely, 
of  the  good-will  item.  In  general,  a  corporation  having  good- 
will of  actual  value,  is  not  ashamed  to  set  the  account  up  for 
what  it  actually  represents. 

Usually,  good-will  is  considered  an  asset  of  diminishing  value 
and,  while  examples  might  be  given  of  many  corporations  whose 
good-will  is  constantly  increasing,  these  same  corporations  prob- 
ably will  be  found  to  be  the  most  industrious  in  washing  the 


380 


ADVANCED  ACCOUNTING 


i4 


good-will  account  from  their  books.  In  other  words,  when  a 
company  needs  its  good-will  asset  the  most  in  order  to  bolster 
up  its  Balance  Sheet,  it  is  probably  worth  nothing,  and  when 
it  needs  the  asset  the  least,  it  is  undoubtedly  worth  a  con- 
siderable sum. 

Patents,  Trademarks,  Etc. — Honestly  expressed,  patents, 
trademarks,  brands  and  rights  are  legitimately  assets  but,  gen- 
erally, they  are  the  tangible  expression  of  an  attempt  to  con- 
ceal the  absence  of  assets  of  real  value;  they  are  too  apt  to 
represent  an  intangible  something  called  ''good-will"  or  "water." 
The  patents  that  are  valuable  are  those  known  as  basic  patents, 
these  covering  an  entire  process  or  a  large  idea  instead  of  a 
minor  detail. 

When  a  patent,  trademark,  brand,  or  right  is  purchased  by  a 
corporation  at  a  large  but  fair  figure,  the  purchase  price  is  the 
cost  to  be  carried  into  the  Balance  Sheet  under  its  true  name, 
A  patent  is  supposed  to  confer  upon  the  patentee  the  exclusive 
right  to  make  and  sell  the  particular  device  described,  but  it  does 
not  undertake  to  stop  infringement.  Being  issued  for  but  seven» 
teen  years,  with  a  remote  possibility  of  renewal,  patents  are 
essentially  a  wasting  asset  to  be  written  down  yearly  to  the 
point  of  extinction  when  the  legal  period  has  expired.  However, 
there  is  a  possibility  existent  that  the  benefits  from  a  patent 
will  not  expire  at  the  time  set  for  the  expiration  of  the  theoretical 
exclusive  right,  since  such  right  may  create  good-will  which 
partially,  at  least,  will  offset  the  effect  of  the  expiration  of  the 
patent. 

Trademarks,  when  purchased  for  cash  value,  properly  may  be 
set  up  as  assets  upon  the  books  of  account.  But  in  the  name 
of  conservatism  careful  managers  usually  will  wipe  out  gradually 
intangible  asset  values  by  annual  charges  against  earnings.  The 
intelligent  investor  is  an  advocate  of  principles  of  conservatism. 
Treasury  Stock  and  Bonds. — These  items  should  appear 
upon  the  Balance  Sheet  as  deductions  from  their  respective  ac- 
counts of  capital  stock  and  bonds  payable,  thus  reducing  the 
gross  amounts  thereof  to  the  point  that  they  will  indicate  the 
amounts  now  issued  and  outstanding.  Never  should  these  items 
be  considered  as  current  assets  or  as  investments. 
An  advisable  policy  for  an  investor  to  follow  is  to  inquire  if 


STATEMENT  ANALYSIS:  FOR  INVESTMENT  PURPOSES    381 

the  treasury  stock  or  bonds  are  being  used  as  collateral;  if  so, 
such  fact  would  give  rise  to  the  existence  of  a  contingent 
liability. 

Investments.— Securities  should  be  analyzed  item  by  item 
to  ascertain  whether  or  not  they  are  worth  the  value  shown 
therefor  upon  the  books.  Securities  held  as  permanent  invest- 
ments properly  may  be  carried  at  either  original  cost  price  or 
par,  provided  a  reserve  be  set  up  to  offset  any  reduction  in  value 
which  may  occur.  Any  appreciation  in  value  had  better  not  be 
booked,  because  a  paper  gain  today  may  be  a  loss  tomorrow; 
safety  lies  in  listing  assets  at  either  cost  or  less. 

The  securities  of  subsidiary  and  affiliated  companies  held  by 
the  parent  company  require  cautious  examination  and  valuation, 
because  the  possibilities  of  concealment  and  fraud  between  the 
books  of  the  holding  company  and  the  books  of  the  subsidiary 
are  almost  unlimited.  The  only  satisfactory  method  of  analysis 
would  seem  to  lie  in  the  examination  of  the  separate  reports 
of  each  subsidiary  corporation  as  well  as  that  of  the  parent 
company: 

1.  Examine  the  report  of  each  subsidiary  as  carefully  as  though 
its  securities  were  the  ones  primarily  under  scrutiny. 

2.  Analyze  with  equal  care  the  report  of  the  parent  company. 

3.  Analyze  a  consolidated  report  of  all  the  companies,  includ- 
ing the  parent  corporation. 

Current  Assets.— These  assets,  popularly  called  quick  assets, 
are  supposed  to  include  only  such  as  will  soon  become  available' 
m  cash  for  the  purpose  of  meeting  debts  which  will  become  due 
m  an  equally  short  period  of  time.  Every  current  asset  item  is 
open  to  question  until  absolutely  verified. 

Since  this  topic  has  been  discussed  at  sufficient  length  in  the 
previous  chapter,  as  well  as  in  the  early  part  of  this  volume,  it 
will  not  be  dwelt  upon  further  in  the  current  one  with  the  excep- 
tion of  the  next  two  topics  below. 

Sinking  and  Other  Special  Funds.— Accumulations  of  profit 
set  aside  periodically  to  meet  a  fixed  obligation  maturing  at  a 
definite  future  date,  as  a  bond  issue,  is  a  sinking  fund.  Such 
a  fund,  if  in  cash,  accumulating  in  a  corporation's  treasury  for 
a  number  of  years,  ofttimes  is  liable  to  prove  to  be  a  source  of 
temptation  to  the  officials.    If  kept  at  the  disposal  of  the  com- 


382 


ADVANCED  ACCOUNTING 


pany  during  all  the  years  intervening  between  the  first  payment 
into  the  fund  and  the  maturity  of  the  debt,  more  than  one  period 
of  stringency  and  more  than  one  time  of  unusual  apparent  specu* 
lative  possibility  will  appear;  then  the  cash  in  the  fund  may 
prove  too  great  a  temptation  and  its  use  be  changed  from  its  in- 
tended purpose.  Payments  into  a  sinking  fund  should  be  made 
to  a  trustee  who  shall  act  as  an  impartial  custodian  thereover; 
perhaps  he  will  use  the  cash  so  paid  in  to  purchase  outstanding 
bonds  in  the  open  market,  thereby  reducing  by  this  amount 
annually  a  portion  of  the  outstanding  debt.  In  any  event,  the 
sinking  fund  should  represent  cash,  or  securities  purchased  with 
the  cash.  If  in  cash,  the  location  and  guardianship  should  be 
known;  if  represented  by  securities,  a  schedule  of  the  sinking 
fund  assets  should  be  available,  with  purchase  and  present 
market  price. 

It  is  common  practice  for  corporations  to  establish  insurance 
funds  for  the  protection  of  their  property  against  fire  and  other 
dangers.  When  established,  the  fund  should  consist  of  cash  or 
of  marketable  securities.  If  the  latter,  a  Bchedule  of  their  con^ 
tent  should  be  available. 

Pension  funds  are  set  aside  by  some  companies  to  provide 
pensions  for  employees  who  have  grown  old  in  service.  As  with 
other  funds,  the  amount  should  be  represented  by  cash  or  by 
marketable  securities. 

Insurance  and  pension  funds  are  not  rightly  considered  blk  free 
assets.  They  are  offset  in  fact,  if  not  on  the  books,  by  a  probable 
loss  in  the  case  of  the  insm'ance  fund  and  by  a  certain  future 
liability  in  the  case  of  the  pension  fund. 

The  so-called  sinking  funds,  some  truly  titled  and  some  not, 
cannot  be  too  carefully  analyzed  regardless  of  their  nature ;  they 
all  involve,  over  a  period  of  time,  large  sums  of  actual  cash. 

Bonded  Indebtedness. — The  only  fixed  or  capital  liability 
relates  to  bonded  indebtedness.  Many  of  the  best  industrial 
corporations  have  outstanding  bond  issues,  but,  as  a  rule,  if  the 
outstanding  issue  is  large,  the  investor  should  proceed  with  cau- 
tion; large  bond  issues  often  have  proved  disastrous  to  a  promis- 
ing industrial  company.  From  the  standpoint  of  solvency,  an 
industrial  concern  depends  upon  the  form  of  its  capitalization 
rather  than  upon  its  amount.     Stockholders,  even  cumulative 


STATEMENT  ANALYSIS:  FOR  INVESTMENT  PURPOSES    383 

preferred  stockholders,  may  be  pacified  or  grimly  be  told  to 
wait  until  the  strength  of  the  treasury  justifies  a  return;  bond- 
holders  will  not  wait.  They  demand  their  pound  of  flesh  and 
become  the  source  of  control  in  case  of  reorganization. 

Careful  attention  should  be  given  to  the  final  date  of  maturity 
and,  should  such  date  occur  during  the  current  year,  the  com- 
pany's plans  relative  to  the  issue  should  be  ascertained.  Perhaps 
the  issue  will  be  refunded  by  the  offering  of  another  issue,  by 
issuing  short-time  notes  or  debentures,  or  by  issuing  additional 
capital  stock.  Sometimes  a  bond  issue  contains  a  conversion 
clause  which  permits  the  conversion  of  the  bonds  into  stock  at 
definite  periods.  All  such  factors  should  be  studied  carefully 
with  the  end  of  determining  satisfactorily  the  debt-paying  abilitv 
of  the  company. 

Current  Liabilities.--If  current  liabilities  are  larger  than 
current  assets,  a  floating  debt  exists  instead  of  what  one  expects 
to  find,— an  excess  of  current  assets  over  current  liabilities  repre- 
senting working  capital.  When  a  corporation  is  confronted  with 
a  floating  debt,  one  may  well  adopt  an  attitude  of  skepticism 
toward  It,  on  the  possibility  that  a  good  investment  proposition 
exiSuS. 

For  further  consideration  of  current  liabilities,  reference  should 
be  made  to  the  previous  chapter,  and  to  the  work  in  the  earlier 
part  of  this  volume,  all  of  which  have  covered  the  topic  suffi- 
ciently. ^ 

Capital  Stock.— The  investor  should  be  thoroughly  satisfied 
upon  the  following  points  with  reference  to  the  capital  stock  of 
the  company  m  which  he  is  interested: 

1.  Its  authorized  issue. 

2.  Its  par  value. 

3.  Amount  of  unissued  stock  in  the  treasury. 

4.  Dividend  rate  on  preferred  stock. 

5.  The  cumulative  feature  of  these  dividends,  and  amount  in 
arrears. 

6.  ':^he  retirement  provisions  and   requirements  of  the   pre- 
ferred stock. 

If,  in  comparing  the  statements  of  successive  years,  the  capital 
stock  Item  shows  an  increase,  the  analyst  should  determine 
whether  this  represents  the  securement  of  new  funds  or  is  merely 


•  > 


i 


384 


ADVANCED  ACCOUNTING 


the  result  of  a  stock  dividend  declared  from  surplus  and  undi- 
vided profits. 

The  wording  of  stock  certificates  should  be  examined  as  care- 
fully as  the  contents  of  a  deed.  Every  word  must  be  essential. 
Preferred  stock  should  be  preferred  as  to  earnings  and,  in  case  of 
dissolution,  as  to  distribution  of  assets.  If  the  dividends  are  not 
cumulative,  such  fact  should  be  known.  If  any  of  the  preferred 
dividends  due  in  the  past  have  not  been  paid,  the  possibility  of 
payment  is  perhaps  the  most  important  consideration  to  keep  in 
mind  if  a  purchase  of  stock  is  contemplated.  Some  preferred 
stocks  participate  in  all  profits  with  the  common  stock  by  the 
terms  of  the  certificate  and,  unless  the  return  on  the  preferred 
stock  is  specifically  limited,  the  preferred  shares  equally  with 
the  common  after  the  preferred  dividend  has  been  paid  in  full. 

The  book  value  of  the  common  stock  is  a  conventional  measure 
in  valuing  securities.  This  is  the  theoretical  value  of  the  common 
stock  as  worked  out  from  the  Balance  Sheet  without  any  con- 
sideration being  given  to  earning  power.  The  liabilities,  includ- 
ing the  bonded  debt  and  the  preferred  stock  at  par,  are  sub- 
tracted from  the  total  asset  fund,  and  the  remainder  divided  by 
the  number  of  common  shares  outstanding,  gives  the  book  value 
per  share.  The  book  value  is  exact  only  insofar  as  the  accounts 
used  are  reliable  and  accurate.  It  is  customar>%  and  generally 
only  fair,  to  disregard  intangible  asset  accounts  as  good-will  in 
computing  book  value.  The  inclusion  of  such  items  destroys  the 
helpfulness  of  the  calculation. 

Changing  the  Capitalization  Form. — If  a  large  bond  issue 
causes  a  burdensome  drain  upon  a  company's  funds,  a  replace- 
ment of  these  bonds  by  common  stock  at  a  fair  ratio  of  exchange 
is  an  act  making  for  strength,  in  that  necessary  and  periodic 
interest  payments  are  turned  into  optional  distributions  of  divi- 
dends. 

A  favored  method  which  is  designed  to  increase  the  proportion 
of  stock  to  bonds,  as  well  as  to  attract  the  needed  capital,  is  to 
issue  convertible  bonds.  If  a  convertible  5  per  cent  debenture 
bond  is  purchased  at  80  and  may  be  converted  into  stock  at  par, 
and  the  stock  advances  from  65  to  120,  for  example,  the  price  of 
the  bond  will  keep  company  with  that  of  the  stock  because,  as 
soon   as  the   stock   is   over  80,   a   bondholder  can  profit   by 


STATEMENT  ANALYSIS:  FOR  INVESTMENT  PURPOSES    385 

exchanging  the  bonds  for  stock.  The  purchaser  of  convertible 
bonds  should  read  carefully  the  text  of  his  security ;  he  may  find 
that  the  attractive  convertibility  feature  is  qualified  by  an  option 
of  the  company  to  retire  these  bonds  at  a  limited  figure. 

Reserves.— No  cash  or  other  special  asset  need  be  represented 
by  the  amount  placed  in  a  reserve  account.  A  corporation  may 
have  a  reserve  for  dividends  in  the  amount  of  a  million  dollars 
and  yet  not  be  able  to  pay  a  dividend  requiring  only  half  that 
amount  of  cash.  The  cash  may  be  low  and  yet  the  reserve  be 
bona  fide,  its  amount,  from  the  asset  side  of  the  Balance  Sheet, 
being  diffused  through  the  assets  as  a  whole. 

Surplus.— Although  a  book  or  nominal  surplus  may  be 
entirely  bona  fide,  one  should  remember  that  financial  strength 
depends  more  upon  the  amount  of  free  working  capital  than 
upon  anything  else;  seldom  will  surplus  be  available  in  cash 
assets  because  it  does  not  necessarily  represent  anything  defi- 
nitely tangible  any  more  than  does  the  ordinary  reserve  account. 
When  the  surplus  item  is  shown-  upon  the  Balance  Sheet  cor- 
rectly, it  should  be  presented  in  two  separate  portions,  so  that 
one  may  not  be  misled  into  believing  that  non-operation  surplus 
accumulations  are  operation  surplus  accumulations. 

Income  Statement— Margin  of  Safety— Average  Profits.— 
Earnings  represent  the  final  measure  of  progress  in  all  commer- 
cial enterprises.  The  income  statement  shows  the  trend  of  a 
business  during  a  specified  period  of  time  with  the  gain  or  loss 
resultant  from  the  activities  thereof.  The  Profit  and  Loss  State- 
ment often  is  as  lamentably  incomplete  as  is  the  Balance  Sheet, 
frequently  being  presented  only  in  devitalized  form.  An  income 
statement  of  the  most  promising  appearance  should  be  examined 
with  an  attitude  of  mind  as  skeptical  as  that  of  a  "Down  East" 
horse  trader;  but  when  it  lacks  definiteness  and  detail,  it  is  al- 
most impossible  of  intelligent  interpretation.  Although  a  lack 
of  standardization  prevents  what  should  be  possible  in  the  way 
of  a  comparison  of  income  statements,  it  is  true,  in  general,  that 
they  are  more  easily  comprehended  than  are  Balance  Sheets. 
One  should  examine  the  Statement  of  Profit  and  Loss  in  connec- 
tion with  the  Balance  Sheet  pertaining  thereto ;  it  is  both  supple- 
mentary and  complementary  to  the  Balance  Sheet. 
Gross  sales  or  earnings,  representing  total  income  from  the 


386 


ADVANCED  ACCOUNTING 


I 


regular  corporate  operations  before  considering  and  making  de- 
ductions for  costs  or  expenses,  compared  year  by  year,  will  indi- 
cate whether  the  volume  of  a  business  is  improving  satisfactorily 
from  period  to  period,  and  whether  the  sales  are  consistent  or 
subject  to  violent  fluctuations;  when  used  with  other  figures,  it 
is  of  marked  importance  in  determining  the  trend  of  actual  profit. 

The  net  sales  figure,  too  seldom  available,  may  be  a  better 
measure  to  use  than  that  of  gross  sales.  The  difference  between 
gross  sales  and  net  sales  in  some  lines  is  considerable,  as  where 
intercompany  transactions  and  operations  are  involved;  in  such 
cases,  it  is  obvious  that  the  net  sales  figure  is  of  such  importance 
that,  without  it,  certain  valuable  comparisons  could  not  be  made. 

The  ratio  of  gross  profits  to  net  sales  should  be  compared  one 
year  with  another  to  see  whether  there  is  an  increasing  or  a 
decreasing  control  over  results.  The  ratio  of  net  profits  to  net 
sales  for  different  years  should  be  calculated  and  compared. 
Special  profits  and  losses  should  be  separated  from  those  due  to 
normal  operations,  and  not  be  consolidated  therewith.  The  in- 
terest item  hereunder  should  show  separately  the  charges  cover- 
ing short-time  debt  obligations,  such  as  bank  loans  and  accounts 
payable;  if  the  Balance  Sheet  indicates  a  small  amount  of  bank 
loans,  while  the  income  statement  shows  a  large  charge  covering 
interest  on  short-time  loans,  it  is  probable  that  the  company 
is- in  arrears  in  its  payments  for  goods,  and  is  losing  substantial 
interest  to  its  trade  creditors.  This  fact  may  be  evidence  of 
weakness  requiring  special  attention. 

After  the  deductions  from  income  have  been  taken  care  of,  a 
corporation's  income  statement  usually  has  several  additional 
items  in  the  nature  of  profit  and  loss  charges  and  credits  to 
absorb  and  set  out.  Finally,  after  all  types  of  items  have  been 
considered,  the  profit  or  loss  amount  resulting  must  be  trans- 
ferred to  the  Surplus  account  and,  in  turn,  this  final  item  must  be 
reconciled  with  the  Balance  Sheet. 

The  "margin  of  safety"  test  is  useful  not  only  in  determining 
the  strength  of  a  corporation,  but  as  a  means  of  checking  up 
other  conclusions.  The  strength  of  a  corporation  may  be  esti- 
mated in  a  fair  way  by  this  test.  The  margin  of  safety  is  the 
proportion  of  net  income  remaining  after  all  fixed  charges  have 
been  paid.     A  company,  for  example,  earning  $10,000.00,  and 


STATEMENT  ANALYSIS:  FOR  INVESTMENT  PURPOSES    387 

having  fixed  charges  amounting  to  $500.00,  has  left  $9,500.00,  or 
a  margin  of  safety  of  95  per  cent;  naturally,  this  concern  is  in  a 
better  condition  than  it  would  be  if  it  had  the  same  earnings  and 
$9,500.00  fixed  charges,  leaving  a  margin  of  safety  of  only  5  per 
cent. 

No  figure  given  out  to  appeal  to  investors  is  more  common  or 
more  deceptive  than  that  of  ''average  profits,"  say,  for  three,  four, 
or  five  years.  Net  income  for  each  of  the  years  concerning  which 
average  profits  are  shown  should  be  set  forth  if  any  dependence  is 
to  be  placed  upon  the  consistency  of  earning  power.  A  business 
concerning  which  its  management  is  not  afraid  to  publish  a 
report  showing  actual  lean  profits  should  be  more  attractive  to 
the  careful  investor  than  the  business  publishing  a  statement 
containing  only  the  always  dubious  mystery  of  "average  profits." 

Illustrative  Problem  and  Solution.— In  order  to  illustrate 
the  application  of  some  of  the  principles  mentioned  in  the  present 
chapter,  the  following  C.  P.  A.  problem  and  a  solution  thereof 
are  submitted: 

Problem.— John  Adams,  a  capitalist,  contemplates  purchasing  the  stock 
of  the  American  Grain  Exporting  Company,  a  corporation  organized  with 
a  capital  of  $200,000.00,  divided  into  1,000  shares  preferred  stock  and  1  000 
shares  common  stock,  par  value  $100.00  each,  6  per  cent,  dividends 
payable  upon  the  preferred  stock  before  any  dividends  are  declared  upon 
the  common  stock. 

This  stock  has  been  offered  to  Mr.  Adams  at  $60.00  per  share  for  the 
preferred  and  $40.00  per  share  for  the  common.  You  are  requested  to 
audit  the  books  of  the  company  and  give  your  opinion  as  to  the  value  of 
the  stock.  You  find  the  foUowing  accounts  to  be  correct,  covering  a  oeriod 
of  one  year.  ^ 

^*®^'  $        900.00 

Accounts  receivable:, 

Good,. 

Doubtful, 

Bad, 
Plant  and  machinery, 
Horses  and  wagons, 
^Merchandise,  inventory, 
Good -will, 

Furniture  and  fixtures, 
Expenses, 
Wages, 
X.  Purchases, 
Claiins  and  rebates. 
Ordinary  repairs, 


$15,000.00 
4,000.00 

6,000.00     $  25,000.00 

75,000.00 

4,000.00 

29,000.00 

50,000.00 

2,000.00 

3,000.00 

15,000.00 

325,000.00 

8,000.00 

9,000.00 


I 


i 


388 

Sales, 

Mortgage  on  plant, 
Accounts  payable, 
Surplus, 
Capital  stock, 


ADVANCED  ACCOUNTING 


$260,400.00 

25,000.00 

42,(X)0.00 

18,500.00 

200,000.00 

$545,900.00     $545,900.00 

V  Inventory  submitted,  $129,000.00  The  company  started  business  six 
years  ago  and  built  the  plant  and  machinery  and  purchased  the  property 
pertaining  to  fixed  capital.  Write  the  report,  commenting  upon  the  advis- 
abiUty  of  the  purchase  and  submit  profit  and  loss  statement  and  balance 
sheet,  after  closing  the  books. 

Solution. — The  solution  to  the  above  problem  is  given  in  the  following 
letter  with  attached  statements: 

Mr.  John  Adams. 
Dear  Sir: 

I  have  examined  the  accounts  of  the  American  Exporting  Company, 
and  the  following  is  my  opinion  of  the  condition  of  this  company  and  the 
value  of  its  capital  stock. 

Accounts  Receivable. — No  reserve  for  doubtful  accounts  seems  to  have 
been  established.  The  amount  of  the  bad  debts  is  24  per  cent  of  the  total 
accounts  receivable,  a  percentage  so  large  that  it  is  apparent  the  bad  debti 
represent  the  accumulation  of  more  than  one  year's  activities.  I  have 
charged  off  the  entire  $6,000.00  bad  accounts,  one-half  of  the  $4.000  00 
doubtful  accounts,  and  I  have  set  up  a  reserve  for  bad  debts  in  the 
amount  of  $1,500.00,  or  10  per  cent  of  the  good  accounts  receivable  so* 
called.    The  accounts  receivable  should  be  examined  again. 

Plant  and  Machinery. — No  reserve  for  depreciation  seems  to  have  been 
set  up  against  the  plant  and  machinery.  However,  since  the  large  repair 
item  would  seem  to  indicate  that  this  asset  is  being  maintained  in  good 
condition,  I  have  set  up  a  reserve  for  depreciation  only  in  the  amount  of 
5  per  cent,  calculated  by  the  straight  line  method,  equal  to  $22,500.00,  of 
which  $3,750.00  pertains  to  the  current  year. 

Horses  and  Wagons. — This  asset  should  be  revalued  at  once,  especially 
since  it  is  probable  the  units  thereof  were  not  all  purchased  when  th« 
business  was  commenced;  the  setting  up  of  a  general  reserve  for  deprecia* 
tion  may  not  be  sufficient.  I  have  set  up  a  reserve  for  depreciation  on  tht 
basis  of  10  per  cent,  $2,400.00  in  all,  $400.00  pertaining  to  the  current  year. 

Merchandise  Inventory. — This  item  should  be  examined  very  carefully, 
especially  since  the  ending  amount  is  so  much  larger  than  the  amount  on 
hand  at  the  beginning  of  the  year.  It  may  be  that  everything  here  is  in 
order  and  that  the  large  amount  of  purchases  will  explain  the  increase. 

Good-will. — This  item  may  or  may  not  be  correct;  the  chances  are  thai 
it  is  incorrect.  It  is  impossible  to  pass  upon  this  item  from  an  examination 
of  the  figures  presented;  the  revenue  accounts  for  a  period  of  at  least  five 
years  past  must  be  scrutinized.  The  item  of  surplus  does  not  represent 
what  the  profits  have  been  in  the  past,  because  no  information  is  deducible 
therefrom  as  to  how  much  of  the  past  profits  have  been  drawn  out  of  the 


STATEMENT  ANALYSIS:  FOR  INVESTMENT  PURPOSES    389 

business  in  the  form  of  dividends;  if  it  were  known  what  dividends  had 
been  drawn  out  in  the  past,  one  would  be  able  to  secure  some  idea  as  to 
what  the  previous  profits  were. 

Furniture  and  Fixtures. — This  asset  should  be  revalued  at  once,  since 
the  setting  up  of  a  general  reserve  may  not  be  sufficient.  As  in  the  case 
of  the  other  fixed  assets  of  a  tangible  nature,  I  have  charged  thereon  an 
estimated  amount  to  cover  depreciation,  on  the  basis  of  10  per  cent, 
$1,200.00  in  all,  $200.00  for  the  current  year. 

Expenses.— Since  the  figures  cover  only  one  year,  this  item  has  been 
charged  entirely  against  the  profits  of  the  current  year. 

Wages. — See  comments  covering  "expenses"  above. 

Purchases. — See  comments  covering  "expenses"  above,  with  the  ex- 
ception that,  here,  the  amount  has  been  adjusted  in  connection  with  the 
beginning  and  ending  inventories. 

Claims  and  Rebates. — See  comments  covering  "expenses"  above.  The 
item  is  rather  large  in  amount  in  view  of  the  fact  that  the  figures  cover 
one  year  only.  I  am  inclined  to  believe  that  the  seUing  department  re- 
quires overhauling  in  order  to  have  the  size  of  this  item  reduced  in  the 
future. 

Ordinary  Repairs.— This  item  has  been  charged  entirely  against  the 
profits  of  the  current  year. 

Sales.— The  sales  are  too  small  considering  the  nominal  capital  of 
$200,000.00.  The  gross  profit  is  only  about  10.86  per  cent  on  sales,  a 
margin  entirely  too  small  upon  which  to  work. 

Mortgage  on  Plant.— Nothing  need  be  said  here,  because  the  criticisms 
presented  above  are  sufficiently  severe  to  cause  the  showing  of  a  loss  for 
the  current  year,  and  the  showing  of  a  deficit  in  the  final  balance  sheet 
(see  below). 

Accounts  Payable.— The  large  size  of  this  item  may  be  due  entirely  to  the 
large  ending  inventory  on  hand,  but,  as  it  stands,  it  is  out  of  proportion  to 
the  good  accounts  receivable. 

Capital  Stock.— The  entire  authorized  issue  of  both  the  preferred  and 
common  stock  has  been  spread  upon  the  books.  No  information  is  given 
as  to  whether  or  not  all  the  dividends  on  preferred  stock  have  been  paid. 
Such  information  would  be  valuable  only  from  the  standpoint  of  determin- 
ing what  is  the  earning  power  of  the  corporation.  Even  if  the  preferred 
dividends  are  in  arrears  to  a  certain  extent,  such  fact  would  not  aflfect  the 
existing  liabiUties  inasmuch  as  you  contemplate  purchasing  all  the  stock 
of  the  company. 

Below  are  attached  the  following  statements  which  I  have  prepared  from 
the  facts  given  me  plus  my  criticisms  above  made: 

1.  Exhibit  A— Balance  Sheet. 

2.  Exhibit  B— Profit  and  Loss  Statement. 

3.  Exhibit  C— Surplus  Account,  adjusted  for  the  six  years. 

Although  the  reserves  set  up  are  exceedingly  reasonable  m  amount,  the 
current  year  shows  a  loss  of  $6,783.33,  and  the  balance  sheet  a  deficit  of 
$16,700.00    The  tangible  assets,  at  the  figures  given,  are  worth  $200,300.00, 


i; 


390 


ADVANCED  ACCOUNTING 


but  there  against  are  liabilities  of  $67,000.00.  which  leaves  a  net  worth  of 
$133,300.00. 

If  you  propose  to  purchase  this  company  in  order  to  liquidate  it,  the 
proposition  would  be  a  good  speculation  at  the  price  asked,  $100,000  00 
provided  you  could  realize  therefrom  an  amount  somewhere  near  the  net 
worth  shown  just  above. 

If  you  propose  to  purchase  this  company  in  order  to  develop  its  business 
proceed  cautiously.    Upon  the  facts  presented,  I  cannot,  rightly,  eetimat^ 
the  real  value  of  the  stock.     Should  circumstances  indicate  that,  under 
your  direction,  the  business  can  be  extended  favorably,  the  price  asked 
$100,000.00,   being  considerably  less  than  the  apparent  amount  of  net 
assets,  would  be  a  point  in  favor  of  making  the  purchase. 

The  above  represents  my  opinion  in  the  light  of  the  facts  as  I  have  found 
them.  It  IS  impossible  for  me  to  be  any  more  definite  than  I  have  been 
unless  a  further  examination  and  investigation  be  made. 

Respectfully  submitted, 

John  Doe,  C.  P.  A. 
BALANCE  SHEET 


Current  Assets: 
Cash, 

Accounts  Receivable, 
Less:  Reserve  for  Bad  Debts, 
Inventory, 

Fixed  Assets: 
Plant  and  Machinery, 

Less:  Reserve  for  Depreciation, 
Horses  and  Wagons, 

Less:  Reserve  for  Depreciation, 
Furniture  and  Fixtures, 

Total  Tangible  Assets, 
Good- will, 
Deficit, 


December  31,  19^ 
Assets  and  Deficit 


•17,000.00 
1,500.00 


Exhibit  A 

t        900.00 

15,600.00 
129,000.00 


$145,400.00 


$75,000.00 
22,500.00  $52,500.00 
$4,000.00 


2,400.00 


1,600.00 
800.00 


54,900.00 


Current  Liabilities: 

Accounts  Payable, 
Fixed  Liabilities: 

Mortgage  Payable, 

Total  Liabilities, 
Capital  Stock: 

Preferred, 
Common, 


Liabilities  and  Capital  Stock 


$100,000.00 
100,000.00 


$200,300.00 
50,000.00 
16.700.00 

$267,000.00 


$  42,000.00 

25,000.00 
$  67,000.00 


200,000.00 
$267,00000 


STATEMENT  ANALYSIS:  FOR  INVESTMENT  PURPOSES    391 


PROFIT  AND  LOSS  STATEMENT 
Year  Ended  December  31.  19 — 


Gross  Sales, 

Less:    Claims  and  Rebates, 
Net  Sales, 

Deduct: 

Cost  of  Sales: 

Inventory,  January  1,  19 — , 
Purchases, 

Total  Goods  Handled, 
Inventory,  December  31,  19 — , 
Gross  Profit, 
Deduct: 

Sundry  Expense^: 

Expenses, 
Wages, 
Repairs, 
Depreciation: 

Plant  and  Machinery, 

Horses  and  Wagons, 

Furniture  and  Fixtures, 
Bad  Debts  (1/6  of  $6,000.00), 
Doubtful  Accounts  (1/6  of  $2,000.00), 
Reserve  for  Bad  Debts, 

Net  Loss  for  Year, 

Surplus  Account 

Balance,  January  1,  19 — , 
Deduct: 


$  29,000.00 
325,00000 

$354,000.00 
129,000.00 


3,000.00 

15,000  00 

9,000.00 

3,750.00 
400.00 
200.00 

1,000  00 
333  33 

1,500  00 


Debit  Adjustments: 

Loss — Current  Year, 

Depreciation: 

Plant  and  Machinery  (five  years), 
Horses  and  Wagons  (five  years). 
Furniture  and  Fixtures  (five  year«) 

Bad  Debts, 

Doubtful  Accounts  Receivable  (five  years), 
Deficit,  December  31,  19—, 


$  6,783.33 

18,750.00 
2,000.00 
1,000.00 
5,000.00 
1,666.67 


Exhibit  B 

$260,400.00 
8,00000 

$252,400.00 


225,00000 
$27,400.00 


34,183  33 

$  6.783  .33 

Exhibit  C 
$18,500.00 


35,200  00 


$16,700  00 


Statement  Of  Resources  and  Their  Application.-At  the 

close  of  the  last  chapter,  the  Comparative  Balance  Sheet  was 
mentioned;  the  statement  to  be  considered  in  the  present  section 
apparently  is  a  logical  outgrowth  of  the  Comparative  Balance 
bheet,  being  designed  to  present  to  better  advantage  than  is  pos- 


392 


ADVANCED  ACCOUNTING 


.'/ 


sible  by  means  of  the  Comparative  Balance  Sheet  itself  the 
information  thereon  available. 

This  statement  is  known  by  more  than  one  name,  among 
which  are: 

1.  Statement  of  Application  of  Funds. 

2.  Statement  of  Fund  Application. 

3.  Statement  of  Application  of  Resources. 

4.  Statement  of  Resources  and  Their  Application. 

To  the  writer,  the  latter  two  titles  more  aptly  reflect  the  con* 
tent  of  such  a  statement  than  any  one  in  which  the  word  **fund" 
is  used. 

This  type  of  statement  has  been  used  by  some  accountants  for 
a  number  of  years,  but  only  recently  has  it  come  into  more  or 
less  general  use.  It  is  apt  to  become  even  more  popular,  however, 
as  time  passes,  when  the  professional  accountant  has  reached 
a  point,  as  some  have,  at  which  he  realizes  that  there  is  more 
to  his  work  than  merely  to  prepare  exhibits  of  what  has  been 
done  and  what  are  present  conditions.  Briefly,  the  advantages 
of  such  a  statement  would  be  about  as  follows: 

1.  It  shows  whether  or  not  the  correct  rate  of  expenditures 
is  being  maintained  as  between  the  current  and  the  fixed 
assets. 

2.  It  shows  whether  working  capital  has  been  increased  or 
decreased. 

3.  It  shows  whether  diflficulty  in  meeting  maturing  obligations 
is  due  to  financial  weaknesfe  or  to  the  injudicious  use  of 
resources  by  means  of  which  fixed  capital  is  being  increased 
at  the  expense  of  working  capital. 

4.  It  shows  what  has  become  of  profits  earned. 

From  the  angle  of  this  statement,  changes  in  the  financial 
condition  of  a  business  during  a  specified  period  of  time  are 
said  to  be  due  to  two  things: 

1.  Profits, — and  dividends  or  drawings. 

2.  Sale  of  stocks  and  bonds. 

Again,  if  the  change  in  the  financial  status  of  an  enterprise  be 
analyzed  properly,  the  analysis  made  should  show: 

1.  The  sources  from  which  the  assets  haw  been  increased  dur- 
ing the  period. 

2.  The  application  of  new  resources  secured  to: 


STATEMENT  ANALYSIS:  FOR  INVESTMENT  PURPOSES    393 

a.  Payment  of  dividends. 

b.  Increases  in  assets. 

c.  Decreases  in  liabilities. 

Only  by  means  of  the  Statement  of  Resources  and  Their 
Application  is  the  above  information  made  readily  available. 
And,  in  accord  with  the  above,  this  statement,  however  prepared, 
is  divided  into  two  portions  or  sections: 

1.  In  one  are  shown  the  resources  provided  during  the  period 
from  the  various  sources  available. 

2.  In  the  other  the  disposal  made  of  these  additional  resources 
is  set  out. 

Naturally,  when  prepared  correctly,  one  section  will  balance 
against  the  other. 

The  statement  in  no  way  is  similar  to  that  of  a  statement  of 
cash  receipts  and  disbursements,  because  items  may  be  included 
therem  which  have  not  been  received  in  cash  and  which  have 
not  been  paid  in  cash.  For  example,  if  a  person  has  $500.00  on 
deposit  m  a  bank,  he  has  an  asset,  a  usable  resource.  If  he  takes 
$300.00  of  this  amount  and  purchases  a  small  automobile  he  is 
changmg  merely  the  form  of  a  portion  of  the  original  asset  held 
so  that,  for  this  portion,  he  has  an  asset  of  a  different  nature- 
his  total  accumulation  of  assets  has  not  changed.  On  the  other 
hand,  instead  of  changing  the  form  of  a  portion  of  his  cash  asset 
this  person  might  purchase  his  car  upon  his  promise  to  pay  for 
It  some  time  in  the  future;  by  so  doing,  his  accumulation  of 
assets  has  increased  over  the  total  held  in  the  beginning  this 
being  caused  by  the  use  or  consmnption  of  a  certain  amoi^t  of 
his  credit.  To  reacquire  this  credit,  he  must  consume  eventually 
a  portion  of  his  cash  resources,  but  such  consumption  does  not 
take  place  at  the  present  moment;  there  is  here  the  receipt  of 
an  Item  not  paid  for  in  cash.  Again,  bonds  may  be  issued  for 
properties;  these  represent  asset  sources  though  the  resources 
are  not  m  the  form  of  cash,  but  in  the  form  of  fixed  assets 

Illustrative  Problem  and  Solution.^The  better  to  show  the 
application  of  the  theory  with  which  the  student  is  confronted 
at  the  present  moment,  the  following  simple  problem  is  given 
with  certain  variations  in  method  of  solution  which  attempt  to 
set  out  the  steps,  if  they  may  be  called  such,  lying  in  between  a 


394 


ADVANCED  ACCOUNTING 


simple  form  of  statement  and  the  form  that  apparently  is  the 
generally  accepted  or  preferred  presentation. 

Problem. — A  comparative  balance  sheet  of  a  certain  enterprise  at  Decem- 
ber 31,  1919,  and  December  31,  1920.  is  Riven  below.  Upon  the  basis 
thereof,  interpret  the  changes  that  have  taken  place  in  the  financial  position 
of  the  company  between  the  two  dates  and,  so  far  as  possible,  indicate 
how  they  were  effected. 

BLANK  MANUFACTURING  COMPANY 

Comparative  Balance  Sheet 

December  31,  1919  and  1920 

December  31  Increase 


Decrease 


Assets  1920  1919 

Real  estate,  $  52,000.00  $  50,000.00 

Plant  and  machinery,     85 ,  000 .  00      85 ,  000 .  00 
Horses  and  wagons,        1 5 ,  000 .  00 
Patents  and  good-will,   20,500.00 


I  2,000.00 


Inventory, 
Accounts  Reed., 
Cash  in  bank, 
Agency  investment, 


65,000.00 
33,000.00 
21,150.00 
15.000.00 


15,000.00 
20,500.00 
49,000.00 
35,000.00 
22,000.00 


16,000.00 


15,000.00 


2.000  00 
850.00 


Net 
assets. 


$306,650.00  $276,500  00     $33,000.00     $  2,850.00 


mcrease     m 


December  31 


$33, 000  00 
Increase 


30,15000 

$33.000.00 

Decrease 


Liabilities 
and 
Capital 
Capital  stock, 
Creditors, 
Bills  payable. 
Mortgage, 
Reserves  for  Depr. : 
Plant  and  machinery. 
Horses  and  wagons, 
Surplus  available, 


1920 


1919 


$200,000.00  $200,000.00 
17,000.00   16,000.00 
30,000.00 
25,000.00 

8,500.00 
2,250  00 
53,900.00   30,500.00 


$  1,000.00 

25,000.00 

8,500.00 

2,250.00 

23,400.00 


$30,000.00 


$306.650.00  $276,50000  $60,150.00  $30,000.00 


30,150.00 


Net  increase  in  li- 
abilities and  capital, 

$60,150.00    $60ri50700 

General  Solution  Comments.— The  Comparative  Balance  Sheet  exhibits 

the  increases  and  decreases  of  the  present  period  over  the  past  period 

relative  to  the  financial  condition  as  of  the  end  of  the  present  period  as 

compared  with  that  as  of  the  end  of  the  past  period.     These  changes  which 


STATEMENT  ANALYSIS:  FOR  INVESTMENT  PURPOSES     395 

have  taken  place  in  the  financial  condition  of  a  business  during  a  specified 
period  of  time  are  expressed  upon  the  Comparative  Balance  Sheet  about 
as  follows: 

1.  Factors  contributing  to  wealth  increase: 

a.  Asset  increases. 

b.  Liability  (and  capital)  decreases. 

2.  Factors  contributing  to  wealth  decreases: 

a.  Asset  decreases. 

b.  Liability  (and  capital)  increases. 

Upon  the  basis  of  the  above,  a  simple  statement  of  summaries  could  be 
prepared,  which  is  similar,  in  part,  to  the  Statement  of  Profit  Determination 
under  smgle  entry,  as  under: 

Increase  in  a^ets,  $33 ,  000 .  00 

Add:  Decrease  in  liabilities,  30  qqq  qo 


Deduct: 

Decrease  in  assets. 

Add:     Increase  in  liabilities. 

Net  profit  transferred  to  surplus, 


$  2,850.00 
36,750.00 


$63,000  00 


39,600  00 

$23.400  00 


The  above  simple  statement  is  useless  from  an  informational  viewpoint- 
it  does  not  set  out  specifically  what  has  become  of  the  profits  earned  plu^ 
what  has  happened  to  the  resources  on  hand  at  the  beginning  of  the  period 

Smce  a  statement  is  desired  which  will  be  of  more  informational  value 
than  the  above,  one  turns  to  the  Statement  of  Resources  and  Their  Appli- 
cation as  a  satisfactory  solution  of  the  problem.  Three  possible  types  of 
this  statement  will  be  considered,  the  development  thereof  proceeding  from 
what  may  be  considered  not  only  an  elementary  form  but  one  unintelligible 
to  the  average  mdividual,  into  the  second  type  that  is  somewhat  better 
andending  with  the  kind  that,  beyond  doubt,  should  represent  the  accepted 

First  Solution.— In  form,  the  first  type  of  statement  is  as  simple  to  prepare 
as  the  anthmetical  summary  presented  just  above.  It  is  arranged  in 
account  form,  the  increase  in  assets  plus  the  decrease  in  liabiUties  offsetting 
the  decrease  in  assets  plus  the  increase  in  Uabilities.  The  adjustment  of 
capital  depends  upon  whether  an  increase  or  decrease  is  noticed  The 
figures  thereof  come  from  the  increase  and  decrease  columns  of  the  Com- 
parative Balance  Sheet;  the  latter  is  the  basis  for  preparing  any  type  of 
this  statement.  The  first  form  of  the  Statement  of  Resources  and  Their 
Application  is  shown  below: 

BLANK  MANUFACTURING  COMPANY 
Statement  of  Resources  and  Their  Application  During  Year  Ended  December  31.  1920 
Resources: 


Decrease  in  Assets  (Consumption) 
Those  of  Prior  Period: 


Application  of  Resources: 
Increase  in  Assets: 


.Accounts  Rec.,  $2 ,  000 .  00  Real  Estate, 

Cash,  850.00    $2,850,000      Merchandise, 


Those  of  Prior  Period: 

S2.000.00 
16,000.00 

$18,000.00 


\ 


t  i 


396 


ADVANCED  ACCOUNTING 


Increase  in  Liabilities: 
(Credit  Consumed) ; 
Those  of  Prior  Period: 


Accounts  Payable,  $1 ,  000 .  00 

New  Liabilities; 

Mortgage 

Pay.,  «25,000.00 

Reinvestment  of 

Prior  Period 

Profit: 

Reserves, 

$10,750.00 
Siirplus, 

23,400.00  34,150.00 


New  Assets: 
Agency  In- 
vestment, 


$15,000.00  $33,000.00 


Decrease  in  Liabilities: 
Those  of  Prior  Period: 
Bills  Payable, 


$30,000.00 


60,150.00 
$63,000.00 


$63,000.00 


Second  Solution. — The  second  form  of  statement  shown  below  requires 
but  scant  explanation.  Note  how  its  arrangement  is  practically  the 
running  form  of  the  statement  shown  above  in  the  first  solution,  except  for 
the  allocation  of  the  current  asset  items.  The  student  should  study  the 
first  form  of  statement,  tracing  its  development  from  the  summary  arith- 
metical expedient  already  criticized,  and  then  compare  its  composition  and 
technique  of  construction  with  the  second  form  below. 

The  arrangement  of  the  second  statement  is  more  to  be  desired  than  that 
of  the  first  type  since  therein  a  separation  is  made  between  the  current  and 
the  fixed  assets  the  better  to  calculate  the  increase  or  decrease  in  working 
capital,  and  because  its  form  is  understood  more  readily  than  the  one 
submitted  under  the  first  solution. 

BLANK  MANUFACTURING  COMPANY 

Statement  of  Resources  and  Their  Application  During  Year  Ended 

December  31,  1920 
Resources  Provided: 

Increase  in  Liabilities: 

(1)  Those  of  Prior  Period: 

Accounts  Payable, 

(2)  New  Liabilities: 

Mortgage  Payable, 

(3)  Reinvestment  of  Prior  Period  Profit: 

Appropriated  for  Reserves, 
Transferred  to  Surplus, 

Resources  Applied: 

Increase  in  Fixed  Assets: 

(1)  Those  of  Prior  Period: 

Real  Estate, 

(2)  New  Assets: 

Agency  Investment, 


$  1,000.00 

25,000.00 

$10,750.00 
23,40000   34.150.00 

$60,150.00 


$  2,000.00 
15,000.00  $17,000.00 


STATEMENT  ANALYSIS:  FOR  INVESTMENT  PURPOSES    397 


Decrease  in  Liabilities: 

(1)  Those  of  Prior  Period: 

Bills  Payable, 

Increase  (Net)  in  Current  Assets: 

(1)  Those  of  Prior  Period: 

Merchandise, 

Deduct  (Decreases): 
Accounts  Receivable, 
Cash, 


30,000  00 


$16,000  00 


$2,000.00 
850.00 


2,85000       13,15000 
$60,150  00 


Third  Solution.— In  compiling  the  third  type  or  form  of  this  statement, 
one  commences  with  the  resources  which  have  been  provided  by  the  profits 
of  the  Deriod  under  review.  Then  the  reserve  provisions  for  the  year  must 
be  written  back,  i.e.,  added  to  the  net  profit.  If  a  business  has  made  a 
gross  profit  of  $5,000.00,  and  has  expenses  of  $3,000.00  (excluding  deprecia- 
tion), the  profit  has  provided  $2,000.00  in  new  resources,  although  the  net 
profit  would  be  much  less.  In  fact,  all  mere  book  entries  of  like  character 
must  be  written  back;  however,  items  Uke  discount  on  stock  and  bonds, 
organization  expense,  and  prepaid  interest  and  insurance  which  are  on  the 
books,  being  carried  as  deferred  charges  (current  assets),  do  not  affect  the 
cash  or  available  resources.  Prepaid  interest,  prepaid  insurance,  and 
prepaid  rent  are  related  to  cash  and  available  resources  because  they  are 
concerned  with  working  capital. 

An  increase  in  a  fixed  liabUity  upon  the  Comparative  Balance  Sheet 
represents  resources  provided,  whereas,  an  increase  in  a  current  liability 
does  not  do  so;  changes  in  the  current  Uabilities  only  affect  working  capital. 
When  a  net  decrease  is  noted  in  working  capital  and  in  deferred  charges, 
such  net  decrease  represents  resources  provided.  If  a  loss  shows  up  after 
the  reserves  are  adjusted,  this  should  be  placed  aa  a  deduction  from  resources 
provided. 

The  statement  prepared  in  accord  with  the  theory  of  the  third  solution  is 
shown  below,  being  accompanied  by  a  supporting  exhibit  prepared  to  show 
the  increase  or  decrease  in  working  capital.  The  third  solution  by  far 
presents  the  accepted  form  for  a  Statement  of  Resources  and  Their  AppU- 
cation. 

BLANK  MANUFACTURING  COMPANY 

Statement  of  Resources  and  Their  Application  During  Year  Ended 

December  31,  1920 
Resources  Provided: 

1.  Surplus  net  profits  for  year  ended  December  31,  1920, 

as  per  Statement  of  Profit  and  Loss,  '    $23  400  00 

2.  Provision  for  reserve,  10;750:00 
6.  Mortgage  payable,                                                                        25  000  00 

Total  resources  provided,  $59,150.00 


I' 


398 


ADVANCED  ACCOUNTING 


Which  Were  Applied  in  the  Following  Manner : 

1.  Expenditures  for  real  estate, 

2.  Investment  in  or  advance  to  agency, 

3.  Increase  (net)  in  working  capital,  as  summari^sed  below, 


$  2,000.00 
15,000.00 
42,16000 

$59,160  00 


Assets: 


Summary  of  Working  Capital 
December  31 

Increase 


1920 


1919 


Decrease 

$  2,000.00 

86000 

$119.150.00  $106,000.00  $16,000.00  $  2,860.00 

13,15000 

$16,00000  $16,000.00 


Inventory,  $  65,000  00  $  49,000.00  $16,000.00 

Accounts  Receivable,      33 ,  000 .00       35 ,  000 .  00 
Cash  in  Bank,  _21 ,  150 .  00       22 ,  000 .  00 

$1 
Net  Increase, 

LiabiHties: 

Creditors, 
Bills  Payable, 


$17,000.00     $16,000.00     $1,000.00 
30,000.00 


$30,000.00 


Net  Decrease, 


$17,00000     $46,00000  $  1,000.00 

29,000.00 


$30,000.00 
$30,000  00  $30,000  00 


Net  Working  Capital,    $102,150  00    $60.000  00  $42,150  00 
Net  Increase  in 


Working  Capital 
(as  above) 


$42,150  00 


CHAPTER  XII 
MERGERS  VERSUS  CONSOLIDATIONS 

Corporate  Combinations.-At  the  present  time,  corporate 
combinations  are  met  with  everywhere,  but  especially  in  the 
industrial,  transportation,  and  public  utility  fields.  Competition 
among  business  enterprises  of  the  same  type  is  said  to  be  an 
Ideal  theoretical  economic  condition,  because  thereunder  no  one 
concern  can  raise  prices  to  an  unreasonable  degree;  if  any  one 
company  attempted  to  do  so,  others  of  a  similar  type  would 
lurnish  the  same  goods  at  a  reasonable  price. 

This  point  of  view,  however,  relates  solely  to  the  purchaser, 
omitting  the  producer  entirely.    Although  the  purchaser  may  be 
protected  by  circumscribing  the  producer  in  the  manner  indi- 
cated, at  the  same  time  the  latter  may  be  made  to  suffer  in  an 
unwarranted  manner,-as  where  the  supply  of  a  certain  product 
exceeds  the  demand  therefor.     Under  this  condition,  some  con- 
cerns will  be  unable  to  dispose  of  their  products  at  normal  prices- 
hence   prices  will  drop  to  a  lower  level,  and  this  lowered  rate 
will  attach  Itself  to  all  concerns  making  that  same  line  of  product 
bmce  prices  at  this  lower  level  cannot  produce  a  reasonable  profit' 
certain  concerns  within  the  particular  group  must  suffer  actual 
loss,  whereas  others  will  fail  completely.    Only  after  a  sufficient 
number  of  concerns  have  failed  to  the  end  that  normal  conditions 
again  are  m  order  can  the  suffering  survivors  increase  prices  so 
as  to  eliminate  the  continuance  of  taking  a  loss 

When  prices  reach  the  old  level,  all  would  be  well,  provided 
they  are  kept  there.  However,  in  order  to  recuperate  from  the 
former  losses,  these  survivors  are  apt  to  make  prices  soar.  Nat- 
urally new  competition  is  invited,  with  the  result  that  sooner  or 
later  the  bottom  again  drops  out  and  another  period  of  depression 
IS  m  lull  swing. 

This  upward  and  downward  trend  of  prosperity  needed  some 
sort  of  control.     The  first  step  toward  the  accomplishment  of 

399 


i 


I 


i 


400 


ADVANCED  ACCOUNTING 


this  end  was  an  attempt  to  have  competitors  become  parties 
to  an  agreement: 

1.  The  so-called  "gentlemen ^s  agreement,"  under  which  terri- 
tory was  divided,  output  restricted,  or  prices  maintained  in 
a  uniform  manner. 

2.  The  pooling  of  interests  looking  toward  a  pro  rata  distri- 
bution of  profits  among  the  members  of  the  pool. 

Although  the  basic  idea  here  apparently  was  laudable, 
unfortunately  it  was  carried  so  far  that  prices  were  increased 
unreasonably  as  before. 

More  or  less  public  hostility  developed  toward  such  combina- 
tions to  the  end  that  the  Sherman  Anti-Trust  Law  was  enacted. 
This  law  looked  toward: 

1.  The  regulation  of  prices,  and 

2.  The  prevention  of  monopoly. 

However,  the  act,  apparently,  took  no  notice  of  the  fact  that 
unless  a  monopoly: 

1.  Controlled  the  sources  of  its  raw  material  supply,  or 

2.  Was  a  natural  monopoly,  it  would  invite  competition. 
The  field  within  which  combinations  may  be  formed  and  their 

formation  have  been  limited  to  a  marked  degree  through  the 
effectiveness  of  both  the  above  act  and  other  laws  designed  to 
prohibit  or  control  business  combinations  which  supposedly  were 
not  operated  in  harmony  with  the  public  welfare.  Nevertheless, 
since  so  many  advantages  accrue  to  a  combination  of  business 
interests,  and  since  many  types  of  corporate  combinations  do 
exist  at  present,  and  will  come  into  existence  in  the  future,  the 
present  topic  should  be  of  considerable  interest  to  the  prospective 
accountant.  And  this  seems  true  even  though  some  business 
combinations  have  been  declared  as  violating  the  anti-trust  laws, 
and  even  though  it  is  questionable  whether  or  not  certain  others 
are  operating  contrary  to  these  laws. 

Advantages  of  Corporate  Combination. — The  simplest  form 
of  combination  represents  the  formation  of  a  partnership  by  two 
competing  sole  traders.  However,  when  an  accountant  refers 
to  a  combination  of  business  interests  it  is  unusual  for  him  to 
think  of  anything  except  a  combination  of  corporations. 

The  advantages  of  practically  all  combinations,  small  or  large, 
may  be  set  out  about  as  follows: 


MERGERS  VERSUS  CONSOLIDATIONS  401 

1.  The  elimination  of  competition  and  the  securement  of  larger 
profits  through  securing  a  partial  monopoly  and  keeping 
sales  prices  at  a  higher  level. 

2.  Economies  looking  toward  expense  elimination: 

a.  Two  concerns  operated  separately  must  each  have  a  sepa- 
rate selling  and  administrative  organization.  When  these 
two  concerns  combine  in  some  way,  it  may  be  possible 
to  eliminate  the  entire  selling  and  administrative  organi- 
zation of  one  unit. 

b.  Each  unit  in  the  combination  may  be  enabled  to  special- 
ize, to  the  end  that  it  can  confine  itself  to  the  product 
it  can  make  best  or  most  economically.  This  tends  to 
give  the  public  more  satisfactory  service  than  otherwise 
would  be  the  case,  at  the  same  time  eliminating  dupli- 
cation in  manufacturing  and  equipment. 

c.  When  specialization  in  product  results,  the  opportunity 
may  present  itself  to  use  expensive  and  highly  specialized 
machinery  more  constantly ;  this  prevents  such  machinery 
possibly  lying  idle  part  of  the  time,  thereby  causing 
a  loss. 

d.  The  combination  will  not  require  as  much  working  capi- 
tal as  the  amount  necessary  were  each  unit  operating 
separately.  The  stock  of  finished  goods  carried  by  sizes 
and  pattern  numbers  will  be  much  less  in  a  combination 
than  where  each  unit  operates  separately. 

e.  Improved  marketing  facilities.  The  field  of  operation 
where  companies  function  separately  is  much  more 
limited  than  where  the  separate  units  are  combined.  The 
combination  has  a  broader  view  of  the  field  and  better 
ability  to  judge  of  possible  demand  than  each  unit  would 
have  if  operating  separately. 

f.  Business  managers,  through  combination,  secure  greater 
facilities  for  dealing  with  labor  than  where  no  combina- 
tion exists. 

g.  Through  combination,  the  best  brains  and  experience  in 
each  of  the  combined  plants  is  made  available  for  deal- 
ing with  the  problems  confronting  each  plant  unit.  Like- 
wise, if  necessary,  the  combination  can  go  out  and  hire 
the  best  men  obtainable,  since  the  cost  thereof  will  not 


I 


402 


ADVANCED  ACCOUNTING 


have  to  be  borne  directly  by  any  one  company;  it  will 
be  distributed  over  all  the  units  combined, 
h.  Better  use  of  by-products. 
3.  Better  facilities  will  be  at  hand  for  borrowing  and  obtaining 

additional  capital. 
Combination    Methods. — The   various    ways    by    means    of 
which   corporate   combinations  may   be   created   are   about   as 
follows : 

1.  Those  of  scant  accounting  importance. 

a.  Gentlemen's  agreements.  In  the  majority  of  states,  until 
near  the  end  of  last  century,  it  was  illegal  for  one 
corporation  to  hold  stock  in  another  corporation  with 
the  end  in  view  of  thereby  controlling  its  activities  and 
operations.  Because  of  such  illegality,  certain  expedients 
were  attempted  to  circumvent  the  intent  of  the  law. 
The  first  known  step  in  this  direction  was  an  attempt  to 
secure  a  combination  of  companies  through  a  mutual 
agreement  of  those  persons  interested  in  the  welfare  of 
the  separate  units.  This  method  of  combination  has 
nothing  of  accounting  interest,  inasmuch  as  the  indi- 
vidual units  or  their  accounting  were  not  affected. 

b.  Pooling  agreements.  The  next  step  in  the  direction  of 
combination  was  known  as  the  ^^pool."  This,  also,  was 
a  form  of  association  based  upon  a  mutual  or  gentlemen's 
agreement.  Its  object,  in  general,  was  to  stabilize  prices 
either  by  restricting  output  or  by  dividing  the  selling 
territories.  This  type  of  combination  worked  nicely 
when  times  were  good,  but  when  hard  times  approached 
the  combination  broke  down;  when  most  needed  as  a 
means  of  securing  cooperation,  it  became  unworkable  and 
dissolution  thereof  followed.  This  method  of  combina- 
tion has  nothing  of  accounting  interest,  since  the  indi- 
vidual units  or  their  accounting  are  not  affected. 

c.  Interlocking  directorates.  The  next  step  in  the  develop- 
ment of  corporate  combinations  looked  toward  a  more 
stable  form  of  administration  than  that  indicated  above, 
with  the  result  that  the  trust  form  of  organization  came 
into  existence.  In  the  beginning,  this  method  of  combi- 
nation took  the  form  of  a  managing  board  of  trustees. 


\ 


MERGERS  VERSUS  CONSOLIDATIONS 


403 


The  companies  in  the  combination  deposited  their  capital 
stocks  with  these  trustees  and  received  trust  certificates 
in  exchange.    Eventually,  even  though  this  form  of  com- 
bination proved  greatly  superior  to  the  pooling   form, 
court  decisions  caused  these  trusts  to  be  dissolved.     As 
an  outgrowth  of  the  trust  idea,  that  of  the  interlocking 
directorates  came  into  being.    Hereunder,  stockholders  in 
two  or  more  of  the   combining  companies   either  had 
themselves  or  trusted  employees  elected  as  members  of 
the  board  of  directors  of  all  the  companies.    To  all  in- 
tents and  purposes,  each  company  is  separate  and  inde- 
pendent from  each  of  the  others,  whereas  in  fact  their 
management   practically   may    be    one    and   the    same. 
Again,  neither  each  individual  company  nor  their  ac- 
counting is  affected  by  this  method  of  combination, 
d.  Lease  of  property.    Sometimes  leases  are  used  as  a  com- 
bmation  means.    Inasmuch  as  the  subject  of  leases  has 
been  discussed  sufficiently  in  previous  chapters,  nothing 
further  need  be  considered  at  this  point. 
2.  Those  of  considerable  accounting  importance.     In  brief 
these  combination  methods  may  be  set  out  about  as  under:' 

a.  Mergers. 

b.  Consolidations    (when  of   considerable   size,  sometimes 
called  amalgamations). 

c.  Parent  companies. 

d.  Holding  companies. 

In  view  of  the  fact  that  these  latter  four  methods  com- 
prise the  remaining  discussion  of  the  present  chapter  and 
that  of  the  next  one,  nothing  further  need  be  mentioned  in 
respect  thereof  at  the  present  moment. 

Merger  Versus  Consolidation— General.— Popularly  the 
terms  combination,  merger,  consolidation,  trust,  and  holding 
company  refer  to  one  and  the  same  thing.  In  fact,  relatively 
few  business  men  are  able  to  distinguish  clearly  between  these 
terms.  Again,  laws  are  not  uniform  even  in  this  regard-  in  New 
Jersey  for  example,  the  term  "merger"  practically  is  synonymous 
with  consolidation,"  whereas  in  New  York  a  clear-cut  distinc- 
tion IS  made  between  the  two.    Because  of  this  lack  of  uniformity 


1 


U 


I  i 


404 


ADVANCED  ACCOUNTING 


which  borders  upon  confusion,  the  accounting  problems  often 
presented  in  the  various  C.  P.  A.  examinations  are  in  no  way 
in  agreement  as  to  the  terms  used.  If  a  problem  is  picked  which 
states  that  it  relates  to  a  merger,  the  chances  are  that  it  really 
concerns  a  consolidation  of  interests,  so  far  as  the  actual  account- 
ing involved  is  concerned. 

Basically,  from  an  accounting  point  of  view,  which,  in  general, 
is  in  accord  with  that  held  in  legal  and  financial  circles,  a  merger 
takes  place  when  an  eodsting  corporation  buys  or  takes  over  the 
assets  and  business  of  one  or  more  other  companies,  the  latter 
completely  merging  their  identity  into  that  of  the  vendee  cor- 
poration. In  other  words,  in  a  merger  one  or  more  concerns  is 
absorbed  by  an  existing  company.  On  the  other  hand,  when  a 
new  corporation  is  formed  to  take  over  the  assets  and  business 
of  one  or  more  concerns,  the  identities  of  the  vendor  company 
or  companies  being  lost  or  fused  in  that  of  the  new  vendee 
corporation,  a  consolidation  takes  place. 

In  the  case  of  a  merger,  the  absorbing  company  already  is  an 
existing  entity,  whereas  in  the  case  of  a  consolidation  the  absorb- 
ing company  first  must  be  chartered  before  the  combination  can 
be  consummated.  In  both  instances,  however,  physical  proper- 
ties primarily  are  dealt  with  and  it  seems  to  be  that,  because  of 
this  fact,  a  confusion  is  apt  to  result  in  that  the  two  ofttimes 
are  referred  to  under  the  caption  of  "merger."  This  ought  not 
to  be  the  case,  inasmuch  as,  from  an  accounting  viewpoint,  each 
will  require  a  different  set  of  accounts,  either  at  the  inception  of 
the  organization  or  continuously  thereafter.  But  in  eitlier  event, 
the  new  organization  acquires  the  net  assets  of  all  the  others 
which,  thereafter,  are  dissolved. 

In  certain  accounting  texts,  a  distinction  is  made  at  variance 
with  the  above,  about  as  follows: 

1.  Combination  by  purchase.    This  corresponds  practically  to 
that  covered  above  by  the  term  ''merger." 

2.  Merger.  This  corresponds  to  that  covered  above  by  the  term 
"consolidation." 

The  use  of  the  method  by  consolidation  is  not  mentioned.  The 
writer  believes,  however,  that  the  distinctions  indicated  in  the 
first  portion  of  the  present  section  are  those  to  be  followed  in 
accord  with  the  correctness  of  the  termn  used. 


MERGERS  VERSUS  CONSOLIDATIONS  405 

Merger  Versus  Consolidation— New  York.— Under  the 
Stock  Corporation  Law  of  New  York,  section  58,  the  merging  of 
stock  corporations  is  permitted.  This  section  reads  about  as 
follows: 

Any  corporation  lawfully  owning  all  of  the  stock  of  any  other  cor- 
poration organized  for  and  engaged  in  business  similar  or  incidental  to 
that  of  the  possessor  corporation  may  merge  such  other  corporation 
with  It  and  be  possessed  of  all  estate,  property,  rights,  privileges  and 
franchises  of  such  other  corporation. 

In  the  case  of  a  merger,  it  is  seen  that  all  of  the  stock  of  the 
subsidiary  company  must  be  owned  by  the  possessor  company. 
In  other  words,  there  must  exist  a  cross  ownership  of  stock 
before  a  merger  may  be  consummated.  This  cross  ownership 
of  stock  is  further  emphasized  by  the  fact  that  to  effect  such  a 
merger,  the  possessor  corporation  must  file  in  the  office  of  the 
Secretary  of  State,  under  its  common  seal,  a  certificate  of  such 
ownership. 

On  the  other  hand,  a  consolidation  is  seen  to  differ  from  a 
merger  in  that: 

Any  two,  or  more,  corporations  organized  for  the  purpose  of  carry- 
ing on  any  kind  of  business  of  the  same  or  similar  nature  which  a 
corporation  organized  under  the  Business  Corporations  Law  might 
carry  on,  may  consolidate  into  a  single  corporation. 

Therefore,  in  case  of  a  consolidation,  no  cross  ownership  of 
stock  is  necessary. 

These  requirements  under  the  laws  of  New  York  do  not  differ 
materially  from  those  presented  under  the  general  consideration 
of  mergers  and  consolidations: 

1.  Merger. 

a.  Similarity.    An  existing  corporation  is  to  be  the  absorb- 
ing company. 

b.  Dissimilarity.    In  general,  so  long  as  an  existing  concern 

becomes  the  absorbing  element,  the  cross  ownership  of 

stock  is  immaterial ;  in  New  York,  a  cross  ownership  of 

stock  is  vitally  important,  under  the  law.     No  merger 

can  be  consummated  without  such  cross  ownership  of 
stock. 


406 


ADVANCED  ACCOUNTING 


2.  Consolidation. 

a.  Similarity.     A  new  corporation  is  to  be  the  absorbing 
company. 

b.  Dissimilarity.    None. 

The  precaution  to  observe  in  each  particular  instance  should 
be  in  conformity  to  what  has  been  indicated  above.  Mere  words 
or  terms  used  should  not  be  taken  for  face  value. 

Illustrative  Merger  Problem— General.— 

Problem. — The  Successful  Mining  Company  has  made  an  agreement  to 
purchase  the  assets  of  another  company,  subject  to  the  lialnhties,  for 
$1,000,000.00,  not  including  the  cash  asset.  Payment  is  to  be  made: 
cash,  one-half;  stock,  one-half.  Par  value  of  the  stock  is  $100.00.  The 
balance  sheet  of  the  vendor  company  is  as  follows: 

Assets 
Cash, 

Accounts  receivable, 
Ore  on  dump, 
Mine, 


$    347.60 

14,200.25 

6,807.00 

700,428.00 

$720,782.85 


Bank  loans, 
Accounts  payable. 
Capital, 
Surplus, 


Liabilities 


$  32,500.00 

28,370.40 

600,000.00 

159,912.45 

$720,782.85 


The  vendee  corporation  neither  has  the  cash  nor  the  unissued  capital 
stock  with  which  to  pay  for  the  properties.  It  has  apphed,  therefore,  for 
authority,  and  has  received  authority,  to  increase  its  capital  stock  to  the 
requisite  amount  needed  for  this  purpose.  Further,  the  needed  amount  has 
been  sold  at  par. 

Required : 

1.  Entries  on  books  of  the  vendor  company. 

2.  Entries  on  books  of  the  Successful  Mining  Company. 

Solution. — There  is  here,  apparently,  a  clear  case  of  merger,  as  generally 
understood  if  interpreted  in  the  light  of  the  previous  discussion.  However, 
if  one  looks  at  a  merger  as  involving  "an  entirely  new  company,  the  latter 
requiring  a  new  charter  to  be  issued  to  it,"  as  some  believe,  this  problem, 
beyond  doubt,  would  fall  under  the  grouping  of  "a  combination  by  simple 
purchase."  In  fact,  in  accord  with  the  manner  in  which  the  present  subject 
has  been  developed,  a  merger  and  a  purchase  practically  are  the  same, 
unless  the  New  York  law  be  applied. 

The  accounting  entries  for  a  merger  depend  upon  which  set  o(  books  is 
under  scrutiny.    In  this  particular  case,  it  is  necessary  to  be  concerned 


MERGERS  VERSUS  CONSOLIDATIONS 


407 


$720,435.25 


first  with  those  of  the  vendee  company.  As  to  the  vendor  company,  one  is 
interested  in  the  closing  entries  required.  These  do  not  differ  materially 
from  those  which  have  been  shown  covering  the  sale  of  a  partnership  business 
to  a  corporation. 

Entries  on  the  books  of  the  vendor  company.  The  first  entry  relates  to 
charging  the  Successful  Mining  Company  with  the  assets  turned  over  to 
it: 

Successful  Mining  Company, 
To — Accounts  Receivable, 
Ore  on  Dump, 
Mine, 
To  record  transfer  of  above  assets 
(state  date)  to  above  company,  in 
accord   with   contract   of   purchase 
and  sale,   and  resolution  of  stock- 
holders, minute  book,  p. 

The  second  entry  relates  to  the  transfer  of  the  liabilities  of  the  vendor 
company  to  the  Successful  Mining  Company.  This  requirement  conforms 
to  the  usual  agreement  entered  into  in  case  of  a  merger: 


;  14,200  25 

5,807  00 

700,428.00 


$32,500.00 
28,370.40 


$60,870.40 


Bank  Loans, 
Accounts  Payable, 

To — Successful  Mining  Company, 

To  record  assumption  of  payment  of 

above  liabilities  on  part  of  the  above 

company,    as  part   payment  for  the 

assets  already  set  out  above;  being  in 

accord  with  contract  of  purchase  and 

sale,   and  resolution  of  stockholders, 

minute  book,  p. . 

The  next  step  relates  to  a  reconciliation  of  the  purchase  price  with  the 
actual  recorded  net  value  of  the  properties  and  assets  taken  over.  The 
net  value  booked,  as  above,  is  $659,564.85.  The  purchase  price  agreed 
upon  is  $1,000,000.00.  The  difference  between  these  two  values  is  $340,- 
435.15,  representing  excess  of  purchase  price  over  net  values  as  carried. 
This  difference  must  be  brought  upon  the  books  by  an  appropriate  entry. 
In  this  connection  it  would  be  proper,  beyond  doubt,  to  open  a  Good-will 
account  (good- will  in  relation  to  consohdations  will  be  discussed  later),  but 
since  this  is  a  mining  company  it  would  seem  to  be  more  logical  to  consider 
that  the  Successful  Mining  Company  values  the  mine  being  taken  over  at 
the  difference  between  the  net  value  of  all  the  other  assets  acquired  and  the 
$1,000,000.00  given  for  the  property  as  a  whole: 
Successful  Mining  Company,  $340 ,  435 .  15 

To— Surplus,  $340,435.15 

The  booking  could  be  made  by  means  of  two  entries,  if  desu-ed,  rather 

than  the  above  one,  as  follows:  first,  a  charge  to  the  Mine  account  and  a 

credit  to  Surplus  account;  second,  a  charge  to  the  vendee  company  and  a 


40S 


ADVANCED  ACCOUNTING 


credit  to  the  Mine  account.  The  labor  thereiinder  seems  somewhat  un- 
necessary, and  the  entry  as  indicated  is  suflBcient  so  long  as  care  is  taken  to 
make  the  explanation  thereof  entirely  intelligible. 

The  account  with  the  Successful  Mining  Company  on  the  books  of  the 
vendor  concern  now  contains  a  debit  balance  of  $1,000,000.(K).  This 
account  will  be  cancelled  when  the  stock  and  the  cash  are  received.  The 
transaction  then  is  closed. 


1500,000.00 
600,000.00 


$1,000,000.00 


Successful  Mining  Company  Stock, 
Cash, 

To — Successful  Mining  Company, 

To  record  receipt  of  5,000  shares 

of   the    stock    of   the    Successful 

Mining   Company   plus   cash    in 

final  payment  for  all  the  assets 

of  this  company  as  per  contract 

of  purchase  and  sale  and  stock- 
holders' resolution,  minute  book, 

p. . 

As  a  final  step,  the  books  of  the  vendor  company  must  be  closed  out. 
When  the  above  entries  have  been  made,  a  trial  balance  of  the  vendor's 
books  will  be  as  follows: 


Cash, 

Successful  Mining  Company  Stock, 

Capital  Stock, 

Surplus, 


I  500,347.60 
500,000.00 


$  600,000.00 
500,347.60 


$1,000,347.60  $1,000,347.60 

Therefore,  an  entry  must  be  made  closing  the  accounts  as  above  shown, 
because  the  stockholders  will  receive  the  stock  of  the  Successful  Mining 
Company  plus  the  cash  on  hand. 

Entries  on  the  books  of  the  vendee  company.  Before  the  Successful 
Mining  Company  can  carry  through  this  deal,  it  must  acquire  the  necessary 
stock  and  cash  with  which  to  do  so.  Therefore,  as  soon  as  the  necessary 
authority  has  been  secured  for  increasing  its  capital  stock,  an  entry  would 
be  made  about  as  follows : 


Subscriptions  to  Capital  Stock, 
To— Capital  Stock, 

To  record  subscriptions  to  the 
10,000  shares  of  the  capital 
stock  of  this  company,  in 
accord  with  minutes  of  stock- 
holders' meeting,  minute  book, 

p. ,  and  per  articles.     This 

entry  is  the  first  one  made,  on 
the  assumption  that  subscrip- 
tions were  received  prior  to 
date  of  booking  same. 


$1,000,000.00 


$1,000,000.00 


MERGERS  VERSUS  CONSOLIDATIONS 


409 


The  next  entry  relates  to  the  receipt  of  cash  from  subscriptions: 

^^'    c,  u      .     .  $500,000.00 

lo— Subscriptions  to  Capital  Stock,  jgQO  000  00 

To  record  cash  received  in  full  pay- 
ment for  5,000  shares  of  this  com- 
pany. 

When  this  cash  is  received,  the  deal  may  be  carried  through  at  once 
Ihe  next  entry  covers  the  recording  of  the  purchase  made: 


Accounts  Receivable, 
Ore  on  Dump, 
Mine, 
To — Bank  Loans, 

Accounts  Payable, 
Vendor  Account, 
To  record  purchase  from  Vendor 
Company  of  the  above  assets 
subject  to  the  above  liabilities 
for  a  consideration  of  $1,000- 
000.00,  as  per  contract  dated 
,    and    minutes   of   stock- 


^       14,200.25 

5,807.00 

1,040,863.15 


t      32,500.00 

28,370.40 

1,000,000.00 


holders,  p. 


As  indicated  already,  it  is  assumed  the  mine  was  valued  at  the  difference 

reil«:et\h^^u;:^r  ""^  '°*'"  "'^^^^  *"  '""•■"'^  *«  "''"■"^ 

VendorAccount,  »1, 000,000  00 

— Cash, 
SubscripUons  to  Capital  Stock,  SOoioOO^OO 

fhfM''^  '"*"^  given  above  for  the  books  of  the  vendee,  it  is  flsumed 

hat  the  new  assets  and  new  liabilities  taken  over  merely  hive  been  add^ 

to  those  already  on  the  books.     Often,  however,  it  is  desirable  to  carry 

separate  accounts  for  the  assete  taken  over  in  order  that  thereby  the  succes*^ 

from  those  of  the  old  enterprise.    The  same  reason,  naturally,  is  not  so 
mportant  as  concerns  the  habilities  although,  at  times  some  sp^iJitem  Tr 
Items  should  be  treated  separately. 

Illustrative  Merger  Problem-New  York.-In  order  to 
Illustrate  the  method  of  a  merger  as  applied  to  a  problem  in 
accord  with  the  laws  of  New  York,  the  following  A.  I.  A.  problem 
IS  used  and  a  solution  presented.  It  is  a  most  excellent  problem 
Illustrative  o  the  principles  set  out  above;  the  solution  presented 
IS  not  official  m  any  way,  being  merely  the  writer's  interpre- 
tation.  ^ 


410 


ADVANCED  ACCOUNTING 


MERGERS  VERSUS  CONSOLIDATIONS 


b 


Problem. — The  following  items  appear  on  the  balance  sheet  of  the  Ameri- 
can Pin  Company,  June  30,  1912:  land,  buildings,  equipment,  etc., 
$335,000.00;  capital  stock  of  the  Bronx  Pin  Ticket  Company,  par, 
$50,000.00;  cost,  $57,400.00;  patents,  $15,000.00;  working  and  trading 
assets,  $37,500.00;  cash,  $10,000.00;  accounts  receivable,  $32,000.00;  due 
from  Bronx  Pin  Ticket  Company,  $375.82;  deferred  assets,  $1,500.00;  first- 
mortgage  6  per  cent,  gold  bonds  payable,  dut^  1922,  $100,000.00;  taxes 
accrued,  $3,250.00;  salaries  and  wages  accrued,  $4,327.82;  accounts  payable, 
$123,749.83;  notes  payable  and  interest,  $80,125.00;  interest  accrued  on 
first  mortgage  bonds  payable,  $2,500.00;  reserve  for  depreciationjof  building 
and  equipment,  $35,000.00;  preferred  capital  stock  outstanding,  $75,000.00; 
common  capital  stock  outstanding,  $50,000.00;  profit  and  loss  surplus, 
$14,823.17. 

The  American  Pin  Company  having  acquired  all  the  capital  stock  of  the 
Bronx  Pin  Ticket  Company,  the  balance  sheet  of  which  appears  below, 
it  is  proposed  to  merge  the  two  companies  as  of  July  1,  1912: 

Assets — ^Land,  buildings,  and  equipment,  etc.,  $260,000.00;  capital  stock 
of  the  Blauser  Pin  Tray  Company  carried  at  par,  $3^,000.00;  patents, 
$22,625.00;  working  and  trading  assets,  $10,000.00;  cash,  $10,366.27;  ac- 
counts receivable,  $37,943.86;  sinking  fund,  $3,236.92;  deferred  charges  to 
expense,  $1,200.00. 

Liabilities  and  capital — First  mortgage  5  per  cent,  gold  bonds  paya))le, 
due  1925,  $50,000.00;  taxes  accrued,  $2,750.00;  salaries  and  wages  ac- 
crued, $3,147.83;  due  to  creditors,  $144,720.30;  due  to  American  Pin 
Company,  $375.82;  notes  payable  and  interest,  $31,372.53;  interest  accrued 
on  first  mortgage  bonds  payable,  $1,250.00;  reserve  for  depreciation  of 
plant  and  equipment,  $27,500.00;  common  capital  stock  outstandingi 
$50,000  00;  profit  and  loss  surplus,  $69,254.57. 

Prepare: 

(a)  The  entries  on  the  books  of  the  American  Pin  Company. 

(b)  The  entries  on  the  books  of  the  Bronx  Pin  Ticket  Company. 

(c)  Balance  sheet  of  the  American  Pin  Company  after  the  merger. 

Solution. — The  first  step  would  seem  to  be  to  prepare  a  coniiolidated 
Trial  Balance  of  the  two  sets  of  books,  since  this  will  show: 

1.  The  situation  with  regard  to  the  individual  companies. 

2.  The  effect  of  the  merger. 

Hence,  such  Trial  Balance  should  be  presented  before  taking  up  the 
specific  requirements  of  the  problem.     It  follows: 

AMERICAN  PIN  CO. 

CoffSOLIDATED  TrUL  BaLANCE  (WoRKCTO  ShBBT) 

June  30,  1912 


American  Bronx  Pin 

Debits                                Pin  Ticket             Total 

Company  Company 

Land,  buildings,  equipment.             $335,000.00  $260,000.00    $596,000.00 
Bronx  Pin  Ticket  Company  Stock, 

$50.000 par.                                       67,400.00  57,400.00    ©$67,400.00 


Consolidated 
Elinunate  Trial 

Balance 
$595,000.00 


Pfctent^  15,000.00 
Working  and  trading  assetfl,  37, 500 . 00 
Cash.  10.000.00 
Accounts  receivable,  32 ,  000 .  00 
Due  from  Bronx  Pin  Ticket  Com- 
pany, 375.82 
Deferred  assets,  1,500.00 
Blauser  Pin  Tray  Company  Stock, 

at  par. 
Sinking  fund, 

Total  Debits. 

Credits 
First  Mortgage  6  per  cent  gold 

bonds,  due  1922.  $100 .  000  00 
Taxes  accrued. 

Salaries  and  wages  accrued,  4, 327 .  82 
Accounts  payable,  123 ,  749 .  83 
Notes  payable  and  interest.  80. 125 .  00 
Interest  accrued  on  bonds  payable,  2, 500 .  00 
Reserve  for  dei»-eciation  of  build- 
ings and  equipment.  35 ,  000 .  00 
Preferred  capital  stock  outstanding,  75,000.00 
Conunon  capital  stock  outstanding,  50, 000 .  00 
Profit  and  loss  surplus,  14 .  823 .  17 
First  mortgage  5  per  cent  gold 

bonds,  due  1925, 
Due  Amoican  Pin  Company, 

Total  Credits. 


22,625.00 
10.000.00 
10,365.27 
37.943.86 


1.200.00 

35.000.00 
$.236  92 


37.625.00 
47.500.00 
20.365.27 
69,943.86 

375.82 
2,700.00 

35,000.00 
3,236.92 


®        375.82 


411 

37.625.00 
47,500.00 
20.365.27 
00.943  86 


2.700.00 

35,000.00 
3.236.92 


$488.775.82    $380.371  05    $869.146.87       $57.775.82    $811.371.05 


$100,000.00 
3.250.00    $    2.750.00         6,000.00 


3,147.83 

144,720.30 

31,372.53 

1. 260.00 

27,600.00 

50.000.00 
69,254.67 

60,000  00 
375.82 


7,475.65 
268,470.13 
111,497.63 

3.750.00 

62,500.00 
75.000.00 

100.000  00    (i)$50.000.00 
84.077.74    ©    7.400.00 


50,000.00 
376.82  ® 


$100,000.00 

6,000  00 

7.475.65 

268.470.13 

111.497.63 

3,750  00 

62.500  00 
75.000  00 
60,000  00 
76.677.74 

60.000  00 


375.82 


«88. 775.82    $380.371  05    $869.146  87        $57.776.82    $811.371  05 

The  entire  capital  stock  of  the  Bronx  Pin  Ticket  Company  was  owned  by 
the  American  Pin  Company  and,  hence,  carried  on  the  books  of  the  latter 
as  an  asset.  Since  the  ownership  of  this  stock  made  the  merger  possible, 
legally,  with  the  result  that  the  accounts  could  be  merged,  it  is  necessary  to 
eliminate  the  stock  asset  from  the  books  of  the  American  Pin  Company  in 
order  to  take  up  thereon  the  assets  and  liabilities  of  the  Bronx  Pin  Ticket 
Company.  Further,  accounts  between  the  two  companies  should  not  be 
carried  as  assets  and  liabilities;  hence,  these  items  must  be  eliminated. 

The  capital  stock  of  the  Bronx  Pin  Ticket  Company  is  carried  on  the 
books  of  the  American  Pin  Company  at  $57,400.00  whereas,  par  is  $50,- 
000.00.  The  former  amount  is  to  be  eliminated  from  both  sides  of  the 
consolidated  Trial  Balance.  Since  the  conmion  capital  stock  of  the  Bronx 
Pin  Ticket  Company  outstanding  is  $50,000.00,  whereas,  the  cost  was 
$57,400.00,  the  $50,000.00  will  be  ehminated  from  the  common  capital 
stock  outstanding,  and  the  difference,  *7,400.0D,  which  from  the  point  of 
view  of  the  merger  becomes  a  surplus  decrease,  should  be  treated  as  such. 
Again,  previous  to  the  merger,  the  Bronx  Pin  Ticket  Company  owed  the 
American  Pin  Company  $375.82,  on  open  account.  In  the  merger  of  the 
two  companies,  ^his  amount  must  be  eliminated,  since  it  is  impossible  for  a 
company  to  owe  itself  money.  On  the  basis  of  the  consolidated  Trial 
Balance,  the  required  entries  may  be  prepared. 

Requirement  (a).  Entries  on  the  books  of  the  American  Pin  Company. 
These  entries  are  set  up  in  summary  form,  rather  than  in  detail,  in  order 
to  conserve  both  time  and  space. 


412 


ADVANCED  ACCOUNTING 


MERGERS  VERSUS  CONSOLIDATIONS 


i 


•379,995.23 
375.82 


$261,116  48 
50,000  00 
69.254.57 


$375.82 


$375.82 


$50,000.00 
7,400.00 


$57,400.00 


Sundry  Assets, 

Accounts  Receivable  (due  from  Bronx  Co.), 
To — Sundry  Liabilities, 

Bronx  Pin  Ticket  Co.  (capital  stock), 
Profit  and  Loss  Surplus, 

To  record  assets,  liabilities,  reserves, 
capital,  and  surplus  of  the  Bronx  Pin 
Ticket  Company  per  merger  terms 
as  of  7/1/12. 
Accounts  Payable  (Bronx  Co.), 

To — ^Accounts  Receivable  (Bronx  Co.), 

To    eliminate    offsetting    accounts 
after  merger. 
Bronx  Pin  Ticket  Company  (capital  stock), 
Profit  and  Loss  Surplus, 
To — Bronx  Pin  Ticket  Company  (capital 
stock-asset). 

To    eliminate    offsetting    accounts 
after  merger  relative  to  capital  stock. 

Requirement  (b).    Entries  on  the  books  of  the  Bronx  Pin  Ticket  Com- 
pany, to  close  the  books. 
American  Pin  Company, 
^  To — Sundry  Assets, 

To    close    asset    accounts    to    the 

American  Pin  Company,  per  merger 

terms  as  of  7/1/12. 
Sundry  Liabilities, 
Capital  Stock, 
Profit  and  Loss  Surplus, 

To — ^American  Pin  Company, 

To    close    the    liabihty    accounts, 

to    American    Pin    Company,    per 

merger  terms  as  of  7/1/12. 

Requirement  (c).     Balance  Sheet  of  the  American  Pin  Company  after 
the  merger,  as  of  July  1,  1912: 

AMERICAN   PIN   COMPANY 

Balance  Sheet 

July  1,  1912 

Assets 


•380,371.05 


$380,371  05 


•261,116.48 
50,000.00 
69,254.57 


$380,371.05 


Capital  Assets: 

Land,  Buildings,  and  Equipment, 
Less — Reserve  for  Depreciation, 

Patents, 

Sinking  Fund, 

Blauser  Pin  Tray  Company  Stock, 

Total  Capital  Assete, 


•595,000.00 
62,500.00    $532,500.00 

37,625  00 

3,236  92 

35,000  00 

$608,361.92 


413 


Current  Assets: 

Accounts  Receivable, 
Working  and  Trading  Assets, 
Cash, 

Deferred  Charges, 
Total  Assets, 


$  69,943.86 
47,500.00 
20,365.27 

$137,809.13 

2,700  00  $140,509.13 

$748,871.05 


Liabilities 


Capital  Liabilities: 

6  per  cent  Bonds  Payable,  1922, 
6  per  cent  Bonds  Payable,  1925, 
Total  Capital  Liabilities, 

Current  Liabilities: 

Notes  Payable  and  Interest, 

Accounts  Payable, 

Bond  Interest  Accrued, 

Taxes  Accrued, 

Salaries  and  Wages  Accrued, 

Capital  Stock  and  Surplus: 


$100,000.00 
50,00000 

$150,000.00 


$3,750.00 
6,000.00 
7,475.65 


$111,497.53 
268,470.13 


17,225  65    $397,193.31 


Capital  Stock  Preferred, 
Capital  Stock  Common, 
Surplus, 

Total  Liabilities, 


$75,000.00 
50,000  00 


$125,000  00  ' 

76,677.74     $201,677  74 

$748,871  05 

Basis  of  Consolidation— Preliminary  Investigation.— When 
a  merger  or  consolidation  is  contemplated,  it  is  advisable  to 
secm-e  the  services  of  an  outsider,— a  promoter,— in  order  that 
an  acceptable  basis  eventually  may  be  presented  under  which 
the  change  m^/  be  made.  In  this  connection,  a  disinterested 
outsider  is  a  useful  man.  Since  each  of  the  interested  parties  is 
bound  to  have  a  most  exaggerated  idea  of  the  value  and  impor- 
tance of  his  own  particular  plant,  as  related  to  the  others  con- 
templating coming  into  the  combination,  no  one  but  a  stranger 
will  stand  much  chance  of  bringing  each  such  interested  party 
to  a  reasonable  level  on  which  the  negotiations  can  continue 
successfully.  This  outsider  will  negotiate  separately  with  each 
unit  and  will  keep  from  each  one  the  terms  he  has  made  with 
each  of  the  others. 

Naturally,  from  the  standpoint  of  the  combination,  it  is  neces- 
sary to  calculate,  upon  some  fair  basis,  the  value  of  each  unit 
coming  into  the  combination.    In  other  words,  conditions  must 


:i; 


414 


ADVANCED  ACCOUNTING 


MERGERS  VERSUS  CONSOLIDATIONS 


be  investigated  to  the  end  that  an  equalization  thereof,  as  be- 
tween each  incoming  plant,  will  be  secured.  In  this  connection, 
two  possibilities  present  themselves  as  the  basis  of  the  proposed 
merger  or  consolidation.  These  two  possibilities  are  best  pre- 
sented in  the  form  of  questions,  to  each  of  which  a  proper  answer 
must  be  secured: 

1.  Should  the  value  of  the  net  assets  of  each  plant  be  used  as  a 
basis  of  fixing  the  ratio  of  exchange  in  stock  or  in  cash,  or 
should  the  earnings  of  each  plant  over  a  period  of  years  be 
used  instead? 

2.  What  relative  value  should  be  assigned  to  net  assets  as 
compared  to  net  earnings  over  a  period  of  years? 

One  plant  may  have  a  large  amount  of  assets  but  may  not  be 
able  to  show  large  earnings;  on  the  other  hand,  a  plant  with  a 
small  amount  of  assets  may  show  large  earnings.  Naturally, 
the  first  plant  will  be  averse  to  a  basis  established  on  earnings; 
and  the  second  plant  will  demur  against  a  basis  of  exchange 
computed  on  net  assets. 

In  seeking  for  the  truthful  and  correct  answers  to  these  ques- 
tions, an  accountant  often  is  called  upon  to  give  his  ideas  as  to 
the  proper  basis  of  combination.  These  ideas  he  crystallizes  into 
the  form  of  statements  after  he  has  made  a  detailed  examination 
of  the  case  under  review.  In  general,  as  a  guide  in  making  such 
investigation,  he  will  endeavor  consciously  or  imconsciously  to 
keep  certain  things  or  points  in  mind.  These  may  be  outlined 
roughly  about  as  follows: 

1.  Where  the  basis  of  exchange  is  to  be  computed  on  net  asset 
values. 

a.  If  possible,  an  appraisal  of  properties  should  be  made: 

i.  By  a  regular  appraisal  company,  preferably,  or 
ii.  By  a  committee. 

b.  If  an  appraisal  is  not  possible,  the  deductions  to  be  made 
must  be  drawn  exclusively  from  facts  collected  in  con- 
nection with  a  careful  audit,  to  the  end  that  the  valuation 
of  each  plant  plus  the  equipment  therein  contained  will 
be  as  correct  as  possible.  Special  consideration  must  be 
given  particularly  to  capital  additions: 

i.  Capital  additions,  in  order  to  be  retained  as  such, 
must 


415 


(1)  Represent  actual  plant  values,  or 
,  (2)  Increase  plant  capacity,  or 
(3)  Reduce  production  costs, 
ii.  Capital  additions  in  each  plant  must  be  handled 
in  a  uniform  manner,  especially  as  concerns 

(1)  Relative  age  of  the  property  and  equipment 
in  use,  and 

(2)  Depreciation. 

(a)  It  must  be  ample. 

(b)  It  must  be  calculated  in  a  uniform  way. 

(c)  Differing  elements  must  be  madeuniform. 

(d)  Differing  conditions  must  be  reconciled. 
2.  Where  the  basis  of  exchange  is  to  be  computed  on  net 

earnings  over  a  period  of  years. 

a.  How  many  years'  profit  should  be  averaged— two,  three, 
four,  or  five? 

b.  Earnings  as  against  expenses. 

i.  Each  business  must  have  its  earning  power  com- 
puted for  a  uniform  period  of  time,  and  preferably 
the  same  period  of  time.  This  period  should  be  at 
least  three  years  in  length  if  it  be  possible  to  make 
it  such. 

ii.  Depreciation    must    be    considered    as    indicated 
above. 

iii.  Revenue  expenses  must  not  be  capitalized.  There- 
fore, capital  additions  must  be  examined  as  indi- 
cated above. 

iv.  In  the  matter  of  production  costs. 

(1)  Where  all  units  are  engaged  in  similar  work, 
they  should  be  determined  in  a  uniform  way. 

(2)  Where  the  units   are   engaged   in   dissimilar 
work,  they  must  be  reduced  to  a  uniform  basis. 

(3)  Labor  and  overhead  items  must  be  appor- 
tioned in  a  imiform  manner. 

(4)  Selling  and  administrative  expenses  are  not 
part  of  production  cost. 

V.  In  the  matter  of  inventories. 

(1)  The   methods   of   inventory-taking   must   be 
uniform. 


416 


ADVANCED  ACCOUNTING 


MERGERS  VERSUS  CONSOLIDATIONS 


417 


I 
i 


] 


r*#« 


(2)  Due  allowance  must  be  made  for  old  and 
obsolete  materials. 

(3)  Extensions  must  be  checked  carefully  and 
parties  taking  same  must  certify  to  correct- 
ness. 

vi.  In  the  matter  of  sales. 

(1)  Sales  in  behalf  of  a  subsequent  period  should 
be  eliminated  because  they  inflate  profits  of 
the  current  period. 

(2)  Consignments-out  and  sales  to  branches  are 
not  sales. 

vii.  Extraordinary  profits  and  losses  must  be  elimi- 
nated, 
viii.  Interest  on  money  loaned  should  not  be  included. 

3.  Where  good-will  enters  into  consideration. 

a.  The  basis  for  calculating  the  value  of  good-will  will  be 
anything  agreed  to  by  the  parties  interested.  Of  the 
many  possible  ways,  two  are  of  interest  at  this  moment 
(further  discussion  of  good-will  is  reserved  to  a  later 
section) . 

i.  Based  upon  profits.  A  certain  number  of  years' 
net  profits,  varying  from  one  to  five,  and  even  more, 
is  purchased.  A  fair  basis,  at  times,  is  found  to 
consist  of  the  purchase  of  a  certain  number  of 
years'  average  profits ;  as,  two  years,  calculated  for 
a  period  of  from  three  to  five  years. 

ii.  Based  upon  excess  profits.  This  contemplates  de- 
termining the  average  profits  for  such  line  of  busi- 
ness. When  this  has  been  done,  the  excess,  equal 
to  the  differences  between  the  actual  profits  and 
the  average,  is  capitalized  upon  some  arbitrary 
basis,  anywhere  from  5  per  cent  up. 

4.  Where  a  partnership  is  a  party  to  the  combination. 

a.  Attention  must  be  directed  specifically  to  items  which 
are  handled  differently  under  partnership  accounting  as 
compared  to  their  handling  under  conditions  of  corporate 
accounting. 

i.  Salaries.     Amounts  representing  salaries  paid  by 


corporations  for  work  of  a  similar  kind  should  be 
included  in  the  Profit  and  Loss  account, 
ii.  Drawings  and  interest  on  investment  are  not  to  be 
considered  in  determining  earning  capacity. 
The  above  illustrates,  in  general,  some  of  the  things  concerning 
which  the  accountant  must  be  familiar  when  confronted  by  a 
merger  or  consolidation  problem.    The  list  is  by  no  means  com- 
plete, as  this  is  not  a  book  on  auditing. 

Consolidation  Capitalization. — The  word  "capitalization"  is 
used  with  a  wide  scope  of  meaning;  its  application  herein  will 
conform  to  use  as  at  the  time  a  corporation  is  formed,  when  it 
refers  to  the  face  or  par  value  of  the  stocks  which  the  corporation 
is  authorized  to  issue. 
Three  different  bases  of  capitalization  may  be  used: 

1.  Earning  power. 

2.  Actual  cost  of  property. 

3.  Cost  of  reproducing  property. 

Of  these  three,  the  first  two  by  far  seem  to  be  the  most  common. 
In  many  instances,  earning  capacity  coupled  with  the  valuation 
of  the  tangible  assets  has  been  found  satisfactory.  Yet  some  of 
the  largest  corporations  apparently  are  capitalized  on  the  earning 
power  basis,  or  on  some  variation  of  it. 

Capitalization  on  the  Basis  of  Earning  Power.— This  basis 
of  capitalization  is  built  upon  the  fact  that  a  corporation  can 
earn  either: 

1.  An  unusually  high  rate  of  dividends  on  the  actual  invest- 
ment, or 

2.  The  usual  rate  of  dividends  on  a  proportionately  higher 
amount  of  investment.  This  point  is  kept  in  mind  by  many 
corporations  for  the  reason  that  it  makes  possible  the  sale 
of  a  large  amount  of  stock. 

It  is  not  considered  good  financing  to  make  the  capitalization 
of  a  company  only  equal  to  the  value  of  its  tangible  assets  on 
the  assumption  that  any  simi  over  that  value  is  water.  A  busi- 
ness man  who  does  not,  on  the  average,  earn  considerably  more 
than  the  usual  rate  of  interest  on  the  actual  cost  of  his  plant 
would  feel  that  he  ought  to  go  out  of  business  and  invest  his 
money  in  securities.  If  earning  capacity  exists,  the  difference 
between  cost  of  plant  and  earning  capacity,  whether  it  is  ab- 


418 


ADVANCED  ACCOUNTING 


t. 


I* 


i 


(  : 


sorbed  in  patents  or  in  good-will  or  in  some  other  asset,  is  just 
as  legitimate  an  asset  as  merchandise,  though,  naturally,  much 
more  difficult  to  appraise. 

Capitalization  does  not,  necessarily,  bear  any  relation  i>o  divi- 
dends paid.  As  long  as  the  dividends  are  honestly  earned  and 
properly  accounted  for,  it  makes  no  difference  whether  the  capi- 
tal is  $500,000.00,  based  on  earning  power,  or  $100,000.00  based 
on  actual  property  investment.  If  $25,000.00  is  earned  during 
the  year,  the  rate  of  return  will  be  25  per  cent,  if  based  on  actual 
property  investment,  or  5  per  cent,  if  based  on  earning  capacity. 
The  amount  of  dividends  earned,  however,  is  the  same  in  either 
case;  it  makes  no  difference  which  capitalization  is  used.  If  stock 
contains  water  the  dividend  rate  will  be  affected;  therefore,  the 
more  important  thing  here  is  ^'dividends."  In  the  final  analysis, 
the  most  important  feature  is  the  relation  between  cash  divi- 
dends taken  out  and  investment.  Dividends  as  percentages  of 
capital  stock  have  but  little  meaning. 

Earning  capacity  is  uppermost  in  the  minds  of  those  who  have 
the  combination  idea  under  consideration.  If  this  were  not  so, 
a  combination  would  not  materialize.  Naturally,  the  economies 
resulting  from  combination  should  increase  earnings  greatly  be- 
yond the  point  reached  when  each  unit  was  operating  separately ; 
this  means,  therefore,  that  past  earnings  may  in  no  way  indicate 
the  possibilities  for  the  securement  of  future  earnings. 

Means  Used  For  Paying  Off  Interests. — In  general,  the 
methods  used  for  paying  off  the  interests  coming  into  a  proposed 
combination  will  depend  upon: 

1.  The  nature  of  the  business. 

2.  The  attitude  of  those  who  are  interested  in  the  combination. 

3.  The  enthusiasm  displayed  by  the  promoter. 

The  possibilities,  however,  will  involve  a  combination  of  some 
of  the  following: 

1.  Bonds. 

a.  For  net  assets — not  advised,  as  fixed  charges  will  be  high. 

b.  For  tangible  assets. 

c.  For  fixed  assets. 

2.  Preferred  stock. 

a.  For  net  assets. 

b.  For  intangible  assets. 


MERGERS  VERSUS  CONSOLIDATIONS 


419 


c.  For  working  capital. 

3.  Common  stock. 

a.  For  good-will. 

b.  For  the  additional  profits  expected  as  the  result  of  the 
combination. 

4.  Cash. 

a.  Seldom  used  except  to  take  up  odd  amounts  remaining 
overdue  to  use  of  one  of  the  above  bases. 
Illustrative  Methods  of  Determining  Capitalization — 
Good-will. — ^When  a  business  is  paid  for  in  the  stock  of  the 
acquiring  company,  the  amount  of  stock  to  be  given  must  be 
determined  upon  an  equitable  basis.  And  as  was  indicated  above, 
two  elements  of  importance  must  be  taken  into  consideration  in 
this  connection: 

1.  Fair  value  of  the  net  assets  from  the  viewpoint  of  a  going 
concern. 

2.  Earning  capacity. 

In  discussing  this  topic  further,  it  seems  expedient  at  this  point 
to  make  a  division  as  follows: 

1.  Issue  of  one  class  of  stock. 

2.  Issue  of  two  classes  of  stock. 

The  first  consideration  below  will  be  where  one  class  of  stock 
is  used  only. 

After  the  net  assets  have  been  valued  upon  what  is  considered 
to  be  a  fair  basis,  whether  by  appraisal  or  by  ordinary  mutual 
agreement,  stock  of  an  equal  amount  in  par  value  should  be 
allotted  therefor  as  the  purchase  price.  Next,  the  earning  power 
must  be  determined  in  order  to  issue  more  stock.  In  this  con- 
nection, it  is  necessary  first  to  separate  earning  power  into  two 
portions: 

1.  Normal  earning  power,  or  normal  rate  of  return.  This  must 
be  done  by  agreement,  after  which  the  rate  will  be  applied 
against  the  stock  set  aside  for  the  net  assets,  to  determine 
the  annual  dividend  return  therefrom  or  thereon. 

2.  Excess  earning  power.  The  remainder  of  the  net  earnings, 
after  eliminating  dividends  as  in  (1),  covering  net  assets, 
is  used  as  a  basis  for  calculating  what  amount  of  stock  shall 
be  given  for  this  excess  earning  power.  The  asset  value 
created  by  such  excess  earnings  is  called  "good-will,"  inas- 


420 


ADVANCED  ACCOUNTING 


4 


^, 


f\ 


I 


much  as  the  new  company  has  taken  over  a  concern  which 
is  established.    Under  such  a  condition,  the  good-will  asset 
must  be  legitimate ;  hence,  stock  may  be  issued  for  it. 
The  valuation  of  the  good-will  asset  for  stock  allotment  has 

been  indicated  above,  but  is  recapitulated  here,  as  to  methods  of 

valuation,  as  follows: 

1.  Certain  number  of  years'  purchase  of  total  profits,  prefer- 
ably the  average  of  a  number  of  years,  in  order  that  normal 
conditions  may  be  approached. 

2.  Certain  number  of  years'  purchase  of  total  profits  in  excess 
of  the  agreed-upon  normal  rate.  Again,  preferably,  the 
average  of  a  number  of  years  should  be  taken,  rather  than 
that  of  the  last  two  or  so. 

3.  Capitalization  of  gross  income. 

4.  Capitalization  so  that  each  unit  will  receive  the  same  earn- 
ings after  the  combination  as  before.  From  the  original 
profits  of  each  concern  there  would  bo  deducted  the  agreed 
dividend  rate  on  net  assets.  The  remainder  then  is  capi- 
talized at  the  agreed  dividend  rate.  To  this  result  would 
be  added  the  capital  allotted  previously  in  order  to  deter- 
mine the  total  capital.  And,  at  the  agreed  rate  of  return, 
the  income  upon  the  total  capital,  as  above,  will  equal  the 
same  amount  as  before  the  combination. 

Methods  (2)  and  (4)  are  preferred  to  (1)  and  (3),  in  that 
the  distribution  seems  more  equitable  thereunder. 

lUustrative  Problem.— Cousider  the  foUowing  C.  P.  A.  problem  and  the 
writer  8  solution  as  lUustrative  of  the  preferred  methods  above  indicated 
I  ^^""7°  'lu'^?T,  T  extensive  dealers  in  plumbers'  supplies,  and  arc 
located  m  Philadelphia;  Smith  &  Rogers  are  conducting  a  similar  business 
in  Pittsburg,  and  James  Watterson,  of  Harrisburg,  Pa.,  is  a  manufacturer 
of  an  improved  valve  and  norzle  as  well  as  several  uther  articles,  all  of  which 
are  used  in  the  plumbing  trade. 

The  territory  covered  by  Brown  &  Jones  and  by  Smith  &  Rogers  overlaps 
to  some  extent,  and  causes  a  sharp  competition.  They  are  both  extensive 
customers  of  Watterson. 

Brown  &  Jones  have  assete  consisting  of  cash  accounts  and  merchandise 
amounting  to  $218,380.00,  and  store  fixtures,  etc.,  worth  $4,500.00  Their 
liabilities,  consisting  of  current  accounts  for  purchases  are  $7,629  40  of 
which  $2,468.00  is  owing  to  Watterson.  During  the  past  three  years  their 
business  was:  Gross,  $739,555.30,  $850,417.84,  and  $1,016,228.54,  respec- 
tively, while  the  net  profits  were  for  the  same  years:  $49,411.20,  $63,619.12 


MERGERS  VERSUS  CONSOLIDATIONS 


421 


Smith  &  Rogers  have  quick  assets  of  $195,620.30  and  fixtures  valued  at 
$6,300.00.  Their  Uabihties  are:  Bank  loans,  $40,000.00;  bills  payable  for 
merchandise,  $24,673.00,  aU  in  favor  of  Watterson;  accounts  payable, 
$18,794.28,  of  which  they  owe  to  Watterson,  $6,287.40.  During  the  past 
three  years  their  gross  business  was  $535,260.18,  $601,341.74,  and  $567,- 
214.96,  and  the  net  profits  before  payment  of  interest  on  loans  were  $46- 
317.46,  $47,934.68,  and  $39,184.72.  ' 

James  Watterson  has  quick  assets  of  $108,496.54,  a  plant  comprising 
real  estate,  buildings  and  equipment  worth  $76,453.83,  clear  of  encum- 
brances. His  liabilities  consist  of  accounts  payable  $26,465.34.  His  sales 
for  the  past  three  years  were  $204,186.32,  $230,419.28,  and  $248,781.20, 
and  his  net  profits  were  $30,847.15,  $35,620.96,  and  $42,208.41. 

These  three  concerns  are  desirous  of  consolidating  their  business,  and 
want  to  form  a  corporation  for  that  purpose.  You  are  asked  to  prepare 
an  equitable  plan  for  the  acquisition  of  these  properties  under  which  pay- 
ment will  be  made  in  stock  of  the  new  company.  In  doing  this,  show  specifi- 
cally the  valuation  you  place  upon  each  business  and  your  method  of 
arriving  thereat,  together  with  your  reasons  therefor. 

Prepare  a  balance  sheet  showing  the  assets  and  liabihties  of  the  new 
company. 

Solution  1.— This  solution  follows  the  first  method  shown  above  based 
upon  a  two  years'  purchase  of  the  average  profits  for  the  three  ye^  con- 
cermng  which  the  actual  profits  are  given.  The  solution,  so  far  as  capitali- 
zation IS  concerned,  is  contained  in  the  following  working  statement. 
Further,  the  Balance  Sheet  showing  the  assets  and  Uabihties  of  the  new 
company  may  be  prepared  readily  from  the  facts  shown  in  this  working 
statement. 


Debits 
Quick  Anets, 
Due  from  Brown  A  Jones, 
Due  from  Smith  &  Rogers, 
Plant  and  Property, 
Fixtures, 

Total  Debits, 

Credits 
Bank  Loans, 
Bills  Payable— Due  Watter- 

son. 
Accounts  Payable— Regular, 
Accounts  Payable — Due 

Watterson, 
Capital, 

Total  Credits, 

Net  Profit*— Last  Three 
Years: 
First  Year, 
Second  Year, 
Third  Year, 

Total  Profits, 


Solution  No.  1 — Workino  Statbitot 
Brown  Smith  James 

&  Jones        &  Rogers      Watterson       Total  Eliminate     Net  Total 

$218,380.00  $195,620.30    $75,068.14  $489,068.44  $489,068.44 

2.468.00  2,468.00  $  2.468.00 
30.960.40  30,960.40  30,960.40 
-^.453.83      76,453.83  76.453  83 

10,800.00  10.800.00 


4,500.00       6.300.00 


$222.880.00  $201.920  30  $184.950.37  $609.750  67  $33.428  40  $576,322  27 


S  40,000.00 


S  40,000.00 


$40,000.00 


24,673.00  24,673.00  $24,673  00 

$  5,161.40   12,506.88  $26,465.34   44,133.62  44,133.62 

2,468.00   6,287.40  8,755.40   8.755  40 

2^5'250  60  118.45302  158,485.03  492,188.65  492.188.65 


$222.880.00  $291.920.30  $184.950  37  $609.7.50.67  $33.428.40  $576,322.27 


$  49,411.20  $  46.317.46  $  30,847  15  $126,575  81 
63.619.12  47.934.68  35,620.96  147,174  76 
85.342.90   39.184.72  _^208^1  j66. 736.03 

$198.373  22  $133.436.86  $108,676.52  $440,486.60 


422 


ADVANCED  ACCOVNTING 


MERGERS  VERSUS  CONSOLIDATIONS 


Average  per  Year,  I  66.124.41  I  44.478.95  $  36.225.51  tl46.828.87 
Good-wiU— TwoYeare'Pur- 

<=•»«•  1132.248.82  I  88.957.90  I  72.451.02  t293.657.74 

Net  Assets  (as  above),  =«==  j— ==== 

Good-will  (as  above),  293  657  74 


Anticipated  Capitalization, 


1785.846. 39    *A 


Solution  2.— The  first  solution  cannot  be  caUed  a  logical  one  inasmuch 
aa  no  consideration  at  all  is  given  to  normal  profits.  In  the  present  solution, 
normal  profits  are  deducted  at  once.  The  normal  rate  of  profit  assumed 
as  agreed  upon  is  taken  as  8  per  cent.  In  the  examination  room  the  first 
solution  probably  would  be  the  only  one  possible  inasmuch  as  therein  no 
assumptions  ought  to  be  made;  the  facts  given  in  a  problem  should  be  used 
as  they  stand.  In  solutions  2  and  3,  certain  assumptions  must  be  made 
since  the  problem  is  incomplete  as  to  information  given. 

SOLPTIGN  No.  2— WOHKINQ  STAmOUIT 


Brown  Etanith  James 

_           .  ^    .    ,                                                          *  Jonea  *  Rogers  Watterson 

Inverted  Capital,  per  previous  workini?  statement.    $215.250.60  S118.453  02  1158.485.03 
Normal  Profit,  8  per  cent  on  invested  capital. 

Average  Profits  per  Year,  per  previous  working 
statement. 


S  17.220.05    $ 


Total 

492.188.1 


9.476.24    %  12.678.80    |  19.375  09 


$66,124.41 
17,230.05 


$44,478.95 
9.476.24 


$36,225.51 
12.678.80 


$48.904.36      $35.002.71    $23,546.71 


$97.808.72      $70.005.42    $47,093.42 


$146.828  87 
$9,375.09 

$107.453  78 

$214.907  56 

$492,188.65 

214, 907. $• 


Normal  Profit  (as  above), 

Ihofits  in  Excess  of  Normal 

Two  Years'  Purchase,  representing  Good-will, 

Net  Assets,  per  previous  working  statement. 

Good-will  (as  above). 

Anticipated  Capitalisation,  $707.096.21    ^ 

Solution  3.— The  third  method  of  capitaKzation,  that  of  capitahzing 
gross  mcome,  cannot  well  be  illustrated  by  the  problem  in  hand  unless  a 
certam  assumption  be  made  relative  to  the  income  capitalization.  This 
will  be  20  per  cent.     The  proposed  capitalization  is  $1,226,331.65. 


Net  assets  and  capital. 
Average  yearly  income. 
Profit  percentage, 

Net  assets. 
Income  at  20  par  cent 
Total, 


B&J 

$215,250.60 

66,124.41 

30.719% 


$215.250. 60 
330,622.00 


S&R 


J.  W. 


$118,453.02  $158,485.03 

44,478.95    36,225.51 

37.649%  22.857% 

Distribution  of  Stock 
$118,453.02     $158,485.03 
222,394.00       181,127.00 


Total 

$492,168.65 
146,828.87 


492,188.65 
734,143.00 


$545,872.60     $340,847.02     $339,612.03     $r;2iB6,l3r:65 

Since  the  total  income  is  $146,828.87,  as  a  yearly  average,  the  rate  of 
mcome  will  be  1 1.973  per  cent.     This  would  be  distributed  about  as  under  • 


Brown  &  Jones, 
Smith  &  Rogers, 
J.  Watterson, 


11.973%  of  $  545,872.60  $65.357  32 
11.973%  of       340,847.02         40.809.81    (discrepancy 
"•»73%of       339.612.03         40.661.74     adjusted  here) 

$1,226,331.65  $146,828.87 


The  result  upon  the  income  hereunder  as  compared  to  previously  operating 
alone,  might  be  shown  as  follows: 


423 


Brown  &  Jones, 
Smith  &  Rogers, 
J.  Watterson, 


Previous  Contemplated       Decrease     Increase 

$  66,124.41  $  65,357.32     $     767.09 

44.478.95  40,809.81       3,669.14 

36,225.51  40,661.74                           $4,436.23 


.        $146,828.87     $146,828.87     $4,436.23     $47436723 

Naturally,  hereunder,  certain  objections  are  noticed,  especially  in  that, 
by  operating  alone,  two  of  the  concerns  will  make  more  than  under  the  new 
order  of  things. 

Solution  4. — Assume,  again,  that  8  per  cent  is  a  normal  profit  return. 
In  the  first  place,  stock  will  be  allotted  for  net  assets  as  before:    ^ 

B&  J  S&R  J.  W.  Total 

$215,250.60  $118,543  02  $158,485.03  $492,188.65 

Next,  the  further  calculation  will  be  about  as  foUows: 


Average  jrr.  profits. 
Normal  profit — 8  per  cent  on  net 
assets. 

Balance,  to  be  capitalized. 

Capitalized  at  8  per  cent. 
Capital  for  net  assets. 

Total  capital, 

8  per  cent  return 


Brown 
it  Jones 

$66,124.41 
17,220.05 


Smith 
A  Rogers 

$44,478.95 
9.476.24 


James 
Watterson 

$36,225.51 


12,678.80 


$48,904.36   $35.002.71   $23,546.71 
$611,304.50  $437,533.80 
215,250.60   118,463.02 


$826.555. 10  $555.986.82 
$  66.124.41   I  44.478.95 


$294,333.88 
158,485.03 

$452,818.91 

S  36,225.51 


Total 
$146,828.87 

39,37509 

$107,453.78 

$1,343,172.18 
492,188.65 

$1,835,360.83   ^ 

%     146.828.87 


Hereunder,  the  return  will  be  the  same  after  the  merger  as 
before.  Hence,  duplication  of  profits  will  be  avoided  and  the 
objections  of  solution  No.  3  are  eliminated. 

Under  the  above  four  solutions  or  methods  of  determining 
capitalization,  the  issue  of  only  one  class  of  capital  stock  has 
been  contemplated ;  hence,  only  one  rate  of  return  has  been  used. 
However,  it  would  seem  to  be  more  in  order  to  find  that  where  a 
combination  is  proposed,  two  classes  of  stock  will  be  issued,— 
preferred  and  common,— preferred  stock  being  issued  for  net 
assets  and  common  stock  for  the  so-called  good-will. 

Where  two  classes  of  stock  are  in  order,  it  would  seem  that 
two  general  methods  exist  in  determining  capitalization: 

1.  Capitalize  good-will  at  an  agreed  rate  on  basis  of  total 
profits.  This  method  is  subject  to  criticism  in  the  same 
way  as  the  third  one  above  explained. 

2.  Capitalize  the  excess  profits  after  dividends  upon  the  pre- 
ferred stock  have  been  considered.  This  would  seem  to  be 
the  preferable  method.  It  is  illustrated  in  connection  with 
the  following  C.P.A.  problem  and  solution. 

Problem.— A  company  is  incorporated  to  purchase  by  an  issue  of  pre- 
ferred and  common  capital  stock  three  concerns.  A,  B  and  C,  doing  the 


424 


ADVANCED  ACCOUNTING 


i 


same  class  of  business.  It  is  found  that  the  a8s<'ts  (by  actual  valuation), 
the  liabilities,  and  the  average  annual  net  profitn  of  each  concern  for  the 
past  five  years,  are  as  follows: 

A  B  C 

Assets  as  valued,                                                $100 .  000  $60 ,  000  1 1 50 ,  000 

Liabilities,                                                                30,000  20,000  50,000 

Annual  net  profits,  average,  five  years,              10,000  15,000  8,000 

It  is  required  to  know  what  amount  of  stock  of  the  new  company  should 
be  allotted  to  each  concern  as  equitable  compensation  for  net  assets  and 
good-will,  and  the  matter  is  referred  to  you  for  rejjort.  What  should  be  the 
amount  of  the  capital  stock  of  the  new  company,  and  how  should  it  ])e 
apportioned  to  A,  B  and  C? 

Solution. — Before  presenting  a  tabulated  solution  to  the  above  problem, 
two  assumptions  must  be  made,  about  as  follows: 

1.  Assume  the  preferred  stock  to  be  issued  at  0  per  cent. 

2.  Assume  the  capitalization  of  good- will  to  be  on  the  basis  of  20  per  cent. 

Determination  of  Net  Assets — Preferred  Stock 

C~  Total 


Assets  as  valued. 
Liabilities, 

Net  assets,  for  which  preferred 
stock  to  be  issued. 


A  15                 

$100,000  $60,000    $150,000  $310,000 

30,000  20,000        50,000  100,000 

$  70,000  $40,000     $100,000  $210,000 


Capitalization  of  Excess  Profits — Common  Stock 


Average  annual  net  profits. 
Preferred  dividends — 6  per  cent, 

Excess  remainder. 

Capitalization  of  remainder  at 
20  per  cent, 


A      B 

$10,000  $15,000 
4,200    2,400 


Total 


$8,000      $33,000 
6,000        12,600 


$  5,800     $12,600         $2,000      $20,400 
$29,000     $63,000       $10,000    $102,000    \ 


A  study  of  the  above  tabulation  will  show  that  6  per  cent  dividends  upon 
the  preferred  stock  and  20  per  cent  on  the  common  stock  will  provide 
the  same  income  after  as  before.  As  a  matter  of  fact,  after  the  preferred 
dividends  of  6  per  cent  have  been  deducted,  the  capitalization  basis  of  the 
remaining  average  income  matters  not,  since  the  proportion  will  be  the  same. 

Summary  of  Stock  Allottment 


B 


Total 


Preferred  stock. 
Common  stock. 

Total, 


$70,000  $  40,000  $100,000  $210,000 

29,000    63,000    10,000   102,000 

$99,000  $103,000  $110,000  $312,000 


Illustrative  Consolidation  Problem — General  Entries. — To 

illustrate  the  general  book  entries  covering  a  consolidation,  the 
following  problem  and  solution  are  offered: 


MERGERS  VERSUS  CONSOLIDATIONS  425 

Pro6Zem.— The  Smith  Manufacturing  Company,  the  Jones  Manufacturing 
Company,  and  F.  McDonald,  Inc.,  amalgamate  their  interests  on  January 
1,  1920,  and  organize  the  Consolidated  Manufacturing  Company,  with  an 
authorized  capital  stock  of  $2,000,000.00,  divided  into  20,000  shares  par 
value  $100.00.  ' 

The  individual  balance  sheets  of  each  respective  firm,  taken  to  represent 
the  exact  and  true  condition  of  affairs  at  that  date  are  as  follows: 

SMITH  MANUFACTURING  COMPANY 


Assets 


Plant  and  machinery. 
Real  Estate  and  buildings. 
Furniture  and  equipment, 
Horses  and  trucks. 
Inventories: 

Raw  material. 

Finished  goods. 

Supplies, 
Bills  receivable. 
Accounts  receivable, 
Cash, 


$  50,000.00 
40,000.00 
20,000.00 
10,000.00    $120,000.00 


$19,000.00 
32,000.00 

4,000.00    $  55,000.00 

9,000.00 

12,000.00 

7,000.00 


Liabilities 
Mortgage  on  plant  (5  per  cent  interest). 
Bills  payable. 
Accounts  payable, 


Capital  stock, 
Surplus, 


Capital  and  Surplus 


83,000.00 
$203,000.00 


$  25,000.00 
14,000.00 
24,000.00    $  63,000.00 

$125,000.00 

15,000.00       140,000.00 

$203,000.00 


JONES  MANUFACTURING  COMPANY 

Assets 

Plant,  equipment  and  machinery,  $100,000.00 

Real  estate  and  buildings,  250  000  00 

Horses  and  wagons,  jg  qqq  qq 

Office  equipment,  g'.OOO.OO    $370,000.00 
Inventory  of  finished  goods,  materials,  goods  in  pro^^ 

cess,  and  supplies,  $1 18 ,  000  00 

Bills  receivable,  22,000.00 

Accounts  receivable,  119  000  00 

Loans  receivable,  16 !  000.00 

^^^'  30,000.00       305.000.00 

$675,000.00 


ktf^^B^D^^^^^ 


426 


ADVANCED  ACCOUNTING 


Liabilities 


i 


Mortgage  on  buildings, 

Interest  accrued  on  above, 

Bank  loans, 

Bills  payable, 

Accounts  payable, 

Dividends  payable, 

Capital  stock. 

Surplus, 

Reserve  for  depreciations. 

Reserve  for  bad  debts, 


$100,000.00 

1,125.00     $101,125.00 
$  14,500.00 

67,275.00 

47,100.00 


$300,000.00 

87,000.00 

$  22,500.00 

5,500.00 


128,875.00 
30,000.00 

387,000.00 

28,000.00 
$676,000.00 


F.  Mcdonald,  incorporated 


Assets 


Plant  and  machinery, 
Inventories, 
Accounts  receivable, 
Cash, 

Accounts  payable, 

Capital, 

Surplus, 


$  75,000.00 
76,500.00 
82,500.00 
66,000.00     $300,000.00 


Liabilities 


$150,000.00 
39,000.00 


$111,000.00 

189,000.00 

$300,00000 

The  average  yearly  net  profits  of  each  respective  firm,  for  a  period  <rf 
five  years,  have  been  as  follows: 

Smith  Manufacturing  Company,  $  19,020.00 

Jones  Manufacturing  Company,  47,400.00 

F.  McDonald.  Incorporated,  15,120.00 

$81,540.00 

Of  the  total  capitalization,  $1,600,000.00  is  to  be  issued  to  the  incor- 
porators for  the  properties  and  good-\^'ill  to  be  sold  to  the  new  company 
after  the  assumption  of  all  liabilities  of  each  renpective  firm;  $400,000.00 
to  be  offered  for  sale  to  the  public. 

The  16,000  shares  issued  and  outstanding  with  the  vendors  are  to  be 
allocated  among  them  as  follows: 

a.  Each  vendor  firm  to  receive  an  amount  of  stock  equal  to  its  net  assets 
(including  cash). 

b.  Each  vendor  firm  to  receive  also  additional  stock  equal  to  its  net 
earnings,  capitalized  at  6  per  cent,  after  deducting  from  the  amount 

to  be  capitalized  6  per  cent  of  its  original  capital. 

c.  Such  stock  as  is  then  unalloted  to  be  divided  equally,  all  firms  share 
and  share  alike. 

Requirements: 
a.  Closing  entries  for  the  books  of  the  Jones  Manufacturing  Company. 


MERGERS  VERSUS  CONSOLIDATIONS  427 

b.  Opening  entries  for  the  books  of  the  Consolidated  Manufacturing 
Company. 

c.  Opening  balance  sheet  of  the  Consolidated  Manufacturing  Company 

d.  Statement  showing  the  amount  of  stock  each  firm  is  to  receive. 
Solution— No  comment  concerning  this  solution  is  deemed  necessary 

masmuch  as  the  presentation  is  believed  sufficiently  self-explanatory. 


Consolidated    Manufacturing    Company 
(vendee), 

^^ — Plant,  equipment  and  machinery, 

Real  estate. 

Horses  and  wagons, 

OflSce  equipment. 

Inventory, 

Bills  receivable. 

Accounts  receivable. 

Loans  receivable. 

Cash, 

Good-will, 
To  record  sale  of  above  assets, 
plus  good-will  to  Consolidated 
Manufacturing  Company,  as 
per  bill  of  sale  on  file,  dated 
1/1/20. 

Mortgage  on  buildings. 
Interest  accrued  on  mortgage. 
Bank  loans. 
Bills  payable, 
Accounts  payable. 
Dividends  payable, 

To — Consolidated  Manufacturing  Co. 
(vendee), 
To  close  and  transfer  all  liability 
accounts  of  this  company  to  the 
ConsoUdated  Manufacturing 
Company  taken  by  latter  in 
part  consideration  for  the  assets 
purchased. 

Reserve  for  depreciation. 

Reserve  for  bad  debts, 

To— Consolidated  Manufacturing  Co. 
(vendee), 
To  transfer  above  reserves. 
Consolidated  Manufacturing  Co.  (stock). 
To — Consolidated  Manufacturing  Co. 
(vendee). 


Requirement  (a) 

$1,165,000.00 


100,000.00 
1,125.00 
14,500.00 
67,275.00 
47,100.00 
30,000.00 


$22,500.00 
5,500.00 


$877,000.00 


$100,000.00 

250,000.00 

18,000.00 

2,000.00 

118,000.00 

22,000.00 

119,000.00 

16,000.00 

30,000.00 
490,000.00 


$260,000.00 


$28,000.00 


$877,000.00 


428 


ADVANCED  ACCOUNTING 


* 


mm 


$490,000.00 


1300,000.00 
677,000.00 


To  record  receipt  of  4,900  shares 
of  the  capital  stock  of  the  Con- 
solidated Manufacturing  Co., 
in  final  payment  for  assets 
transferred. 

Good-will, 
To — Surplus, 

To  close. 

Capital  stock, 
Surplus, 

To — Consolidated  Manufacturing  Co. 
(stock), 

To  record  distribution  of  stock 
in  Consolidated  Manufacturing 
Co.  to  stockholders  of  this  Com- 
pany in  exchange  for  stock  of 
this  company  held  by  them. 


Requirement  (b) 

CONSOLIDATED  MANUFACTURING  COMPANY 

Incorporated  under  the  laws  of  the 

State  of ,  with  an 

Authorized  Capital  of 

$2,000,000.00 

Divided  into  20,000  shares  of  $100,  par 


$4  W,  000. 00 


$877,000.00 


Subscriptions  to  capital  «tock, 

Unsubscribed  capital  stock, 
To — Capital  stock. 

To  record  authorized  issue,  and 
subscription  to  16,000  shares. 

Plant,  good-will  and  sundry  assets, 
To — Sundry  vendors, 

To  record  the  transfer  to  this 
company  of  all  right,  title,  and 
interest  of  above  vendors  in  all 
assets  set  out  in  bill  of  sale  un- 
der date  of  1/1/20. 

Sundry  vendors, 

To— Sundry  liabilities, 

To  record  assumption  by  this 
company  of  the  above  as  set  out 
in  said  bill  of  sale. 

Sundry  vendors, 


$1,600,000.00 
400,000.00 


$2,000,000.00 


$2,062,000.00 


$2,062,000.00 


$434,000.00 


$434,000.00 


$28,000.00 


$1,600,000.00 


MERGERS  VERSUS  CONSOLIDATIONS 

To — Reserve  for  depreciation, 
Reserve  for  bad  debts, 

To  record  reserves  transferrea 
to  oflFset  valuations  of  assets  as 
booked  above  to  which  reserves 
apply. 
Sundry  vendors, 

To — Subscriptions  to  capital  stock. 

To  record  payment  and  cancel- 
lation of  subscription  by  trans- 
fer of  above  mentioned  assets. 
Plant  and  machinery 
Real  estate, ' 
Horses  and  wagons, 
Furniture  and  equipment. 
Inventories  (per  detail  schedule), 
Bills  receivable. 
Accounts  receivable, 
Loans  receivable, 
Cash, 
Good- will, 

'^o — Plant,  good-will  and  sundry  assets, 
To  spread  above  assets  upon  the 
books  in  detail. 
Sundry  habilities, 
To — Mortgage  payable, 
Bills  payable, 
Accounts  payable, 
Bank  loans, 

Interest  accrued  on  mortgage, 
Dividend  of  Jones  Co.— payable, 
To  raise  above  liability  accounts 
on  books  in  detail. 

Requirement  (c) 
CONSOLIDATED  MANUFACTURING  COMPANY 

Balance  Sheet 


429 

$22,500.00 
5,500.00 


$1,600,000.00 


$225,000.00 
290,000.00 

28,000.00 

22,000  00 
249,500.00 

31,000.00 
213,500.00 

16,000.00 
103,000.00 
884,000.00 


$2,062,000.00 


$434,000.00 


$125,000.00 

81,275  00 

182,100  00 

14,500  00 

1,125.00 

$30,000.00 


Real  estate, 
Plant  and  machinery, 
Furniture  and  equipment. 
Horses  and  wagons, 

Less:   Reserve  for  Depreciation, 
Inventories, 


January  1,  1920 
Assets 


$290,000.00 

225,000.00 

22,000.00 

28,000.00 

$565,000.00 
22,500.00 

^49,500.00 


$  542,500.00 


I 


430 


ADVANCED  ACCOUNTING 


»:i 


Bills  Receivable, 
Accounts  Receivable, 

Less:    Reserve  for  Bad 
Debts, 

Loans  Receivable, 
Cash, 

Good-will, 


$  31,000.00 
213,500.00 

$244,500.00 
5,500.00 


239,000.00 

16,000.00 

103,000.00 


Liabilities 


Mortgage  Payable, 

Bills  Payable, 

Accounts  Payable, 

Bank  Loans, 

Jones  Company,  Dividend  Payable, 

Interest  Accrued, 

Capital  Stock  Authorized, 

Less:  Unissued, 


607,000.00 

884,00000 

$2,034,000.00 


$     125,000.00 


81,275.00 

182,100.00 

14,500.00 

30,000.00 

1,125.00 


$2,000,000.00 
400,000.00 


309,000.00 


1,600,000.00 


Requirement  (d) 
Smith 


Jones 


$2,034, 00000 


McDonald 


Net  assets. 
Good-will, 

One-third  stock  remaining  un- 
allotted. 
Total, 

Summary: 
Smith, 
Jones, 
McDonald, 

Total, 


$140,000.00  $387,000.00  $189,000.00 
192,000.00   490,000.00   102,000.00 

33,333.33    33,333  33    33,333  34 


$365,333.33  $910,333.33  $324,333  34 

$  365,333.33 
910,333.33 
324,333  34 


$1,600,000.00 


CHAPTER  XIII 

PARENT  VERSUS  HOLDING  COMPANIES; 
CONSOLIDATED  STATEMENTS 

Introduction.-Accounting  principles  are  fixed  and  constant 
whereas,  as  time  passes,  new  forms  of  business  develop,  each  of 
which  has  certain  features  peculiar  to  itself.  And  because  of 
these  peculiarities,  the  general  principles  of  accounting  must  be 
applied  thereto  m  such  a  manner  that  the  financial  statements 
adopted  will  present  a  clear-cut  picture  and  record  not  disturbed 
by  any  of  the  unusual  items  encountered.  Naturally,  the  method 
of  application  depends  upon  the  conditions  encountered  in  any 
particular  case,  and  the  type  of  development  reflected  therein 
This  IS  true  especially  as  to  consolidated  statements;  these  can-' 

nli'  ??r*^^^  P^^P^^^y  ^i^h«"^  clearly  comprehending  the 
nature  of  the  organization  or  organizations  the  results  of  whose 
operations  and  activities  are  set  forth  best  in  statements  desig- 
nated  as  "consolidated."  ^ 

In  the  last  chapter  an  attempt  was  made  to  formulate  clearly 
a  distinction  between  a  merger  and  a  consolidation,  each  of 
which  has  features  peculiar  to  itself;  consolidated  statements  are 
not  concerned  with  these  two  types  of  organization.  Two  other 
classes  were  mentioned  above  concerning  which  nothing  as  yet 
has  been  said,--the  parent  company  and  the  holding  company 
It  IS  m  connection  with  these  latter  two  that  consolidated  IZ 
ments  are  used.  Therefore,  as  a  point  of  commencement  for  the 
work  of  the  present  chapter,  it  seems  necessary  first  to  distingu  sh 

moreTna^^^^^^^^^^^  ^^.'  ^  ^^^^^"^  --P->^'  ^  ^-tinctl 

tTrpnH  T  '^^^'  ^"^  ^^"  °^^  ^^^^y«  understood.     To 

this  end,  It  appears  appropriate  to  summarize  briefly  the  distinc 

to  secure  the  proper  viewpoint  relative  to  the  accounting  nrin 
ciples  used  m  this  chapter;  by  so  doing,  confusion  oug^not "^ 

431 


Ht 


432 


ADVANCED  ACCOUNTING 


u 


r 


result  as  to  understanding  the  exact  place  in  corporate  accounting 
at  which  consolidated  statements  may  appear. 

Mergers  and  Consolidations  Versus  Parent  and  Holding 
Companies. — In  accord  with  the  idea  mentioned  in  the  intro- 
duction above,  the  following  information  is  presented  in  outline 
form : 

1.  Mergers  and  consolidations. 

a.  In  general. 

i.  Physical  properties  are  dealt  with.  This  compre- 
hends that  the  plants  and  other  property  plus  the 
liabilities  of  the  merging  or  consolidating  com- 
panies are  taken  over.  The  new  organization 
acquires  the  net  assets  of  all  the  other  companies, 
after  which  the  latter  are  dissolved. 

b.  Merger. 

i.  The  complete  amalgamation  of  the  constituent 
companies  into  a  single  corporation,  the  latter  be- 
ing one  of  the  constituent  companies.  No  new 
corporation  is  formed.  One  company  acquires  title 
to  the  property  of  another  company. 

c.  Consolidation. 

i.  The  complete  amalgamation  of  the  constituent 
companies  into  a  new  corporation  formed  for  the 
purp>ose  of  taking  over  the  net  assets  and  busi- 
nesses of  the  constituent  companies. 

2.  Parent  and  holding  companies. 

a.  In  general. 

i.  The  constituent  companies  are  controlled  through 
the  purchase  of  sufficient  stock  so  that  control  will 
be  secured  through  a  majority  vote  in  the  stock- 
holders' meetings.  Each  controlled  company,  as 
in  the  past,  retains  its  separate  corporate  existence 
and  operates  as  a  distinct  organization. 

b.  Parent  company. 

i.  Both  properties  and  securities  are  dealt  with.    A 
parent   company   arises   because   of   one   of   two 
things: 
(1)  It  organizes   a   new   subsidiary    corporation 


PARENT  VERSUS  HOLDING  COMPANIES  433 

which  is  controlled  through  ownership  of  a 
majority  of  the  voting  stock,  or 
(2)  It  purchases  the  stock  of  one  or  more  corpora- 
tions, which  thereby  become  its  subsidiaries. 
ii.  A  parent  company  is  an  operating  company  doing 
business   under   its   own    name;    each    subsidiary 
company,  also,  does  business  under  its  own  name 
in  lines  allied  to  those  of  the  parent  company. 
Example:    In  the   problem   previously   discussed, 
that  of  the  American  Pin  Company  and  the  Bronx 
Pm  Ticket  Company,  before  the  merger  was  con- 
summated, there  existed  an  example  of  a  parent 
company  organization,  in  that  the  American  Pin 
Company  was  an  operating  company  and  at  the 
same  time   held   the   controlling   interest   in   the 
stock  of  the  Bronx  Pin  Ticket  Company,  its  sub- 
sidiary.    The   Bronx   Pin   Ticket   Company   did 
business  under  its  own  name. 
c.  Holding  company. 

i.  Only  securities  are  dealt  with, 
ii.  A  holding  company  is  not  an  operating  company. 
Its  principal  assets  are  the  stocks  of  the  corpora- 
tions it  controls  through  ownership  of  a  majority 
of  the  voting  stock.  Under  this  method,  a  holding 
company  is  the  financial  organization  and  the  sub- 
sidiaries are  manufacturing  or  selling  organiza- 
tions. In  general,  it  may  be  said  that  the  only 
assets  a  holding  company  has,  other  than  the  stock 
of  subsidiaries,  would  be  cash  and  office  equip- 
ment; it  may  not  even  have  the  asset  of  office 
equipment  if  it  uses  the  office  of  one  of  its  sub- 
sidiaries as  a  place  of  business. 

in^ZT  ^^"JP^y  A^^^^'^ting.-Once  more  it  seems  desirable 
to  return  to  the  illustration  made  use  of  above.     When  the 

prT'l\  n      ^""^""^  ^""''^'^''^  ""  «^  ^^'  «^«^k  of  the  Bronx 
th.  hn  t     ?rT^'  ^^"^  ""^^  ^^'  P^^^^^«^  thereof  recorded  on 
h    books  o     he  American  Pin  Company?    The  purchase  of  all 
the  stock  of  the  Bronx  Pin  Ticket  Company  had  the  effect  o 


434 


ADVANCED  ACCOUNTING 


•I 


purchasing  that  company,  but  the  fact  remains  that  this  actually 
did  not  happen.  The  Bronx  Pin  Ticket  Company  retained  its 
separate  identity,  carried  on  business  under  its  own  name,  and 
operated  with  a  separate  organization.  Therefore,  so  far  as  the 
American  Pin  Company  was  concerned,  the  only  entry  required 
on  its  books  would  be  relative  to  the  stock  purchase: 

Bronx  Pin  Ticket  Company — Capital  Stock,  $57,400.00 

To — Whatever  Accounts  Required  Credit  for  Payment,  57,400.00 

The  stock  purchased  would  be  taken  up  at  the  price  actually 
paid  therefor,  since  such  price  is  presumed  to  represent  the  actual 
value  of  the  purchased  stock. 

Holding  Company  Accounting. — ^If  the  American  Pin  Com- 
pany did  not  operate  its  own  manufacturing  plant,  but  merely 
purchased  the  stock  of  the  Bronx  Pin  Ticket  Company  in  order 
to  control  the  latter  and,  if  the  stock  of  the  American  Pin 
Company  were  owned  by  the  officers  of  the  Bronx  Pin  Ticket 
Company,  a  clear  case  of  a  holding  company  would  exist.  The 
accounting  entries  required  to  reflect  this  stock  ownership  upon 
the  books  of  the  American  Pin  Company  would  be  exactly  the 
same  as  those  shown  above.  But,  as  already  indicated,  a 
marked  difference  would  exist  between  the  Balance  Sheets.  The 
items  of  plant,  machinery,  equipment,  accounts  receivable,  and 
even  cash,  as  shown  on  a  parent  company's  Balance  Sheet 
would  not  be  found  upon  the  Balance  Sheet  of  a  holding  com- 
pany. 

However,  certain  accounts  are  peculiar  to  a  holding  company 
as  will  be  noticed  later,  particularly  in  connection  with  Con- 
solidated Balance  Sheets ;  these  result  from  intercompany  trans- 
actions: 

1.  Assets. 

a.  Investments  in  subsidiaries. 

b.  Advances  to  subsidiaries. 

2.  Liabilities. 

a.  Advances  from  subsidiaries. 
Again,  from  the  standpoint  of  the  subsidiary   company,  in 
agreement  with  the  above,  the  following  accounts  may  appear: 
1.  Assets. 

a.  Advances  to  holding  company. 


PARENT  VERSUS  HOLDING  COMPANIES 


435 


2.  Liabilities. 

a.  Advances  from  holding  company 

subsidiary  would  remain  as  before.    There  would  be   how' 
ever   a  change  required  on  the  Stock  Ledger,  lookL  to- 

inTor  seS/i     t      .r^^^^^^^  ^^'^"^^  ^"^  manufactur- 

ing or  selling  activity,  the  holding  company's  chief  sourrP  nf 

income  would  be  from  the  dividends  of^he  suSi^Z     itl 

staff.     Sometimes,  these  expenses  must  be  paid  by  the  sub 
sidiar,es  being  prorated  among  them  as  cost  of  services  rend "ed" 
by  the  holding  company  to  the  subsidiaries.  renaerea 

The  holding  company's  investment  in  its  subsidiaries  is  onp 
which  practically  has  the  character  of  a  fixed  T^^ZZeZ 

ndZro  Tr '' ""'"'  ^  '^^^^^^  ^^-p-^  exists  ;u' 

them     lit     V^  subsidiaries  and  operate  through  it^ 

them.    Again,  if  this  controlling  interest  is  to  be  sold   it  mZ 

mmmm 

a  ?ea?'catrrhoM  *''  '"''"«  '"'"P^"^  '^"^  *°  ^^is  point, 
1! Tk  Tu  "^'"^  company  has  been  assumed   namelv 

that  the  proper  viewpoint  miy  be "eeutd  for  tt  7'  "'•°'''"' 
consolidated  statements,  in  order  thaf  fh.  1  h  ^'^"="^^'°°  °f 

be  prepared  properly     The  noints  «t  ''  '^'"^^^^^  ""^^ 

discussion  ma'y  b'e  iL  Jttd  S  fs  loTwT  ""'  '''  '"^'^ 
1.  Only  a  preponderating  portion  of  the  stock  of  the  under- 


H 


\ 


436 


ADVANCED  ACCOUNTING 


V    1 1 


I 


lying  companies   is   held  by   the   so-called   holding   com- 
pany. 
2.  The  so-called  holding  company  may  be  an  operating  com- 
pany in  which  event  it  is  not  entirely  a  financial  organiza- 
tion. 
But  in  any  event,  the  pure  holding  company,  or  the  hybrid, 
completely  controls  the  others,  known  as  underlying  or  sub- 
sidiary companies,  to  the  end  that,  because  it  can  elect  what- 
ever directors  and  officers  it  chooses,  it  can  dictate  the  policy 
to  be  pursued.    Likewise,  the  principles  of  accounting  involved  in 
the  discussion  that  follows  remain  the  same  whether  working 
with  one  form  or  with  the  other.     In  other  words,  the  term 
"holding  company"  as  contemplated  herein  in  connection  with 
consolidated  statements,  is  used  in  the  more  general  sense  as 
referring  to  any  type  of  combination  in  which  one  corporation 
exercises  stock  control  over  other  corporations. 

One  corporation  may  hold  the  stock  of  another  corporation 
and,  in  turn,  this  other  corporation  may  hold  the  stock  of  a  third. 
As  a  matter  of  fact,  no  limit  exists  as  to  the  extent  of  these 
holdings  except  that  set  out  in  the  certificate  of  incorporation  or 
in  the  law.  Regardless  of  the  number  of  inter-ownerships,  this 
holding  function  is  a  positive  one  just  so  long  as  each  holding 
corporation  controls  a  majority  of  the  outstanding  capital  stock 
of  the  other  or  others.  There  may  be,  or  there  may  not  be,  a 
minority  interest,  an  interest  held  by  outsiders.  If  8o,  these 
outsiders,  concerning  whom  more  will  l^e  said  later,  have  little, 
if  any,  power  in  management;  but  they  are  entitled  to  propor- 
tionate dividend  rights. 

Consolidation  of  Balance  Sheets  Versus  Consolidated 
Balance  Sheets. — ^When  a  proposition  is  fomented  looking 
toward  the  consolidation  of  several  companies,  it  is  necessary 
first  to  secure  a  sort  of  bird's-eye  view  of  the  assets  and  liabil- 
ities to  be  involved.  This  is  accomplished  by  gathering  them 
together  in  a  simple  way  into  the  form  of  a  Balance  Sheet,  such 
statement  being  titled  a  "Consolidation  of  the  Balance  Sheets 
of  Companies  X,  Y,  Z,"  as  on  a  certain  date.  The  method  of 
compiling  this  Balance  Sheet  is  a  simple  one  involving  merely 
the  gathering  into  one  amount  the  assets  and  liabilities  of  each 
of  the  consolidating  units.    If  X,  Y,  and  Z  have  each  a  capital 


i 


PARENT  VERSUS  HOLDING  COMPANIES  437 

stock  of  $500,000.00,  for  example,  the  capital  stock  of  the  three 
companies  combined,  naturally,  will  be  11,500,000.00.  In  other 
words  the  promoter  of  the  combination  desires  to  know  ho^  the 
eonsohdatzon  will  work  out  and  what  the  probable  cond't  on 
of  the  contemplated  combination  will  be;  therefore,  he  totals  aU 
the  ,tems  on  each  individual  Balance  Sheet  into  a  comb  Led 
statement  which,  when  completed,  shows  the  condition  o^Se 

worlin   \    /TP'''**'""  °^  ^^^  "^^^^"  «°l"mn  amounts  in  the 
woj^ng  sheets  for  the  illustrative  problems  lator  in  the  present 

npSV'^'n"*''",'  ^'""^'  ^  Consolidated  Balance  Sheet  is  prepared 
penodacally  after  the  combination  has  been  formed  t^  reflect 

oLfdTred      ""'"'r  ''  l'^  "'^"'^  «^-P  °^  -ffil-ted  clpanS 
Z  i  of  the  rt°'''T*'r  ''''''  '''''''  °^  tJ^^  -«ets  which  the 

Zt  be°Le'  outtf  ThTir  Th*'^  T^''  ''''  ^^^"^^"^ 
„»,„  *      •    7  ^®®**-    ^he  subsequent  portion  of  thi<! 

chapter  as  devoted  to  a  discussion  of  the  Consolidated  Balance 
Sheet  pnmar,Jy.    It  is  plain  that  the  effect  of  this  procedure  s 

tLTJu^        n  subsidiary  company  or  companies,  to  the  end 

rtv  ^d^Tf  ^^'^°"  '^^^*  contains  only  Ictual  prl^' 
erty  and  debts  due  from  or  to  outsiders 

Law  and  Accounting  as  Related  to  Consolidated  State 
ments.-Under  the  law,  the  ownership  of  the  stock  of  a  comZv 
does  no   mean  ownership  of  its  assets.    If  Jones  o^s  stocTTnT 
corporation,  he  has  no  rights  in  its  assets  bevond  an  eT^tlble 

Z  W  r  *''"'''^  '''  °'  P^'*  °^  his  hoWings  to  som  one 
dse  but  he  cannot  ask  the  corporation  whose  stock  he  iol3s 
to  redeem  ,t  and  give  back  to  him  the  assets  he  handed  ovr  to 
the  company  m  exchange  therefor.  Likewise,  if  Jones  slouW 
be  replaced  by  a  corporation,  the  latter  would  be  in  no  be  te^  a 
position  relative  to  what  has  been  mentioned  above  tSan  Jots 
he  company  holding  the  stock,  replacing  Jones,  would  be  In  the' 
same  position  as  a  stockholder  as  was  Jones 

Again  no  stockholder  has  any  right  to  corporate  profits 
beyond  his  equitable  right  thereto  as  already  indicated  un  I 
after  the  board  of  directors  has  declared  a  d'ivi^'d  This  i^ 
true  regardless  of  the  manner  in  which  the  surplus  ha    teen 


I  n 


I 


II  } 


438 


ADVANCED  ACCOUNTING 


accumulated.  Therefore,  from  the  viewpoint  of  a  stockholder, 
he  cannot  consider  anything  as  income  from  corporate  holdings 
until  he  has  been  actually  given  the  right  thereto  by  board 
action.  This  is  true  whether  the  stockholder  owns  1  per  cent 
or  100  per  cent  of  the  outstanding  capital  stock. 

As  a  result  of  the  above,  under  the  law,  if  a  Balance  Sheet  be 
prepared  of  the  stockholder's  business,  such  statement  should 
be  prepared  in  conformity  to  the  ideas  expressed  in  the  last  two 
paragraphs. 

However,  from  the  accounting  viewpoint,  any  statement 
should  present  facts  in  the  clearest  possible  way  and,  as  a 
result,  an  accountant,  unless  absolutely  prohibited  by  law  from 
so  doing,  may,  and  should,  go  beyond  the  legal  boundaries  as 
recorded  and  make  use  of  methods  which  he  knows  are  correct 
according  to  accounting  principles.  The  time  eventually  will 
come  when  the  law  must  recognize  established  custom  or  prac- 
tice, provided  this  is  sufficiently  well  established  as  a  matter 
of  public  opinion.  If  the  accountant,  therefore,  uses  correct 
principles  and  methods  in  his  work,  it  matters  but  little  whether 
current  legal  opinions  support  or  do  not  support  him. 

Therefore,  although  consolidated  statements  have  no  basis 
under  present  laws,  accountants  are  justified  in  preparing  them 
since  they  are  in  accord  with  the  established  principles  of  his 
science,  and  are  not  absolutely  prohibited  by  law. 

A  financial  statement  must  express  the  truth  in  so  far  as  is 
humanly  possible,  whether  it  pertains  to  financial  condition  or 
to  operation.  And  since  the  usual  types  of  these  statements  do 
not  truly  state  the  facts  which  are  of  interest  and  of  importance 
to  the  stockholders  in  organizations  of  the  holding  company 
type,  an  accountant  must  present  this  information  so  that  the 
facts  will  be  disclosed  properly.  Legally,  each  subsidiary  organ- 
ization is  separate  and  distinct  from  that  of  each  other  sub- 
sidiary organization  and  from  the  holding  company  which  con- 
trols all  of  them.  Practically,  however,  from  the  viewpoint  of 
the  holding  company  stockholders,  this  legal  separation  amounts 
to  but  little.  The  holding  company  stockholders  care  nothing 
at  all  about  the  relation  existing  either  between  the  various 
subsidiaries  or  between  the  subsidiaries  and  the  holding  com- 
pany.   To  them,  the  holding  company  plus  its  subsidiaries  con- 


PARENT  VERSUS  HOLDING  COMPANIES 


439 


stitutes  one  group,  and  to  them,  the  relation  this  group  has  to 
outsiders  alone  is  of  primary  importance.  Therefore,  since  the 
usual  forms  of  the  Balance  Sheet  and  of  the  Profit  and  Loss 
Statement  are  deficient  in  showing  the  exact  relation  existing 
between  the  group  of  companies  and  the  outside  world  (creditors, 
bondholders,  and  minority  stockholders) ,  these  statements  must 
be  prepared  in  such  a  manner  that  the  indicated  deficiency  will 
be  eliminated.  Hence,  the  Consolidated  Balance  Sheet  and  Con- 
solidated Income  Statement. 

Information  Not  Disclosed  Except  By  Use  of  Consoli- 
dated Statements.— If  a  Balance  Sheet  and  Statement  of  Profit 
and  Loss  be  prepared  in  usual  form  for  the  holding  company 
only,  as  alone  from  the  books  of  the  holding  company,  noth- 
ing would  be  indicated  therein  beyond  its  own  particular  activ- 
ities, plus  dividends  received  from  the  subsidiaries  and  interest 
earned  on  bonds  of  the  subsidiaries.  From  the  standpoint  of 
the  group  as  a  unit,  many  items  of  importance  would  not  be 
disclosed  by  such  statements,  as: 

1.  One  subsidiary  may  have  no  business  whatsoever  of  a 
profitable  nature,  whereas,  another  may  have  plenty  of 
profitable  business,  each  of  these  two  possibilities  being 
due  to  manipulation  by  the  holding  company. 

2.  The  holding  company  might  hide  its  own  losses  by  covering 
them  up  with  dividends  received  from  the  subsidiaries. 

3.  The  holding  company  might  do  a  profitable  business,  but 
one  or  more  subsidiaries  might  have  continued  operation 
losses. 

4.  Dividends  received  by  the  holding  company  from  a  sub- 
sidiary may  in  no  way  represent  income;  they  may  have 
been  declared  out  of  capital. 

5.  The  holding  company  may  have  received  no  dividends  from 
a  subsidiary,  because  of  non-action  by  the  directors,  even 
though  the  subsidiary  may  have  had  a  most  profitable 
year. 

6.  Inter-company  transactions  may  be  large  in  amount,  yet 
from  the  viewpoint  of  the  group  as  a  whole,  they  may 
represent  nothing  actually  in  the  way  of  either  receivables 
or  payables. 

7.  The  holding  company  may  take  up  the  dividends   from 


I 


440 


ADVANCED  ACCOUNTING 


PARENT  VERSUS  HOLDING  COMPANIES 


441 


profitable  subsidiaries  and  forget  taking  up  losses  suffered 
by  the  unprofitable  subsidiaries. 

Since  all  of  these  factors  are  not  in  accord  with  accounting 
principles,  their  non-recognition  in  statement  preparation  may 
cause  a  statement  to  be  misleading  if  not  actually  fraudulent. 
The  effect  thereof  would  be  seen  in  the  market  fluctuation  of 
the  price  of  the  stock  of  the  holding  company.  As  to  any  one 
of  these  possibilities  of  misstatement,  the  law  actually  may  not 
be  violated  even  though,  as  a  result  thereof,  the  general  public 
easily  might  be  defrauded. 

As  a  final  point  under  this  section,  it  seems  well  to  crystallize 
the  conditions  under  which  such  statement  would  be  used: 

1.  The  Consolidated  Balance  Sheet  is  a  Balance  She(>t  of  the 
holding  company  only  when  the  latter  owns  the  entire 
capital  stock  of  its  subsidiaries. 

2.  It  should  never  be  used  unless  it  presents  a  mon*  correct 
picture  of  facts  than  does  the  regular  Balance  Sheet  of  the 
holding  company. 

3.  If  the  holding  company  has  a  controlling  interest  in  the 
subsidiaries,  the  Consolidated  Balance  Sheet  usually  will  be 
the  better  way  by  means  of  which  to  show  financial 
condition. 

4.  If  the  holding  company  has  no  controlling  interest  in  the 
subsidiaries,  its  use  is  questionable  since  the  holding  com- 
pany may  not  control  the  policies  of  the  subsidiaries. 

Carrying  Investments  at  Actual  Value. — Since  a  holding 
company  is  a  stockholder  in  its  subsidiary  companies,  it  has,  as 
such  stockholder,  an  undivided  interest  m  the  net  assets  of  its 
subsidiaries  equal  to  the  amount  of  its  stock  holdings.  Such 
investments  should  be  carried  at  actual  worth. 

If  such  investments  be  carried  at  cost,  conservatism  will  result 
provided  such  cost  is  equal  to  actual  value.  Although  cost  and 
value  may  be  in  agreement  at  the  time  of  purchase,  the  two  will 
never  be  in  agreement  for  any  length  of  time;  value  is  a  fluctu- 
ating quantity,  going  up  and  down  as  conditions  change.  If 
value  drops,  cost  will  be  too  high;  if  value  increases,  cost  will  be 
too  low. 

If  the  value  of  such  an  investment  depreciates,  the  cost  could 
be  scaled  down  to  the  same  level,  and  no  one  then  well  could 


say,  theoretically  at  least,  that  conservatism  is  not  practiced. 
However,  upon  what  basis  shall  the  scaling  be  made?  One 
person's  word  may  be  as  good  as  another's,  with  the  result  that 
the  ultimate  value  decided  upon  will  not  be  the  same  if  persons 
with  differing  qualifications  have  this  task  entrusted  to  them. 

But  assume  that  the  persons  entrusted  with  such  revaluation 
are  qualified  for  the  task  in  a  general  way.  What  difficulties 
might  they  encounter  which  will  hinder  them  in  digging  out  the 
actual  truth?  Suppose  they  decide  to  revalue  upon  the  basis  of 
the  market  price  of  the  stock.  What  might  occur?  Every  one 
knows  that  market  values  are  affected  by  many  outside  con- 
ditions in  no  way  related  to  actual  facts.  If,  then,  the  market 
value  of  a  particular  stock  is  taken  as  a  basis  for  revaluation, 
such  revaluation  may  be  absolutely  incorrect. 

Again,  suppose  these  men  realize  the  possible  fallacy  indicated 
above,  and,  as  a  result,  attempt  a  revaluation  based  upon  actual 
conditions.  They  may  be  thwarted  in  their  efforts  in  this  direc- 
tion because  of  the  physical  impossibility  of  performance. 

If  investments  are  carried  at  cost,  another  disadvantage  may 
result,  not  indicated  above,  in  that  even  though  the  holding  com- 
pany Balance  Sheet  may  disclose  the  truth  insofar  as  concerns 
the  amount  of  its  capital  invested  in  subsidiaries,  the  holding 
company  earning  account  may  be  at  fault  in  that  therein  the 
entire  earnings  upon  such  capital  may  not  be  shown.  In  other 
words,  if  the  accumulated  surplus  of  a  subsidiary  company  is 
not  fully  distributed  as  dividends,  the  appreciation  of  such  sub- 
sidiary company's  stock  value  due  to  an  increase  in  surplus  will 
not  be  taken  up  on  the  books  of  the  holding  company,  the  result 
being  that  the  latter's  true  earnings  will  be  understated. 

Lastly,  even  though  the  revaluation  method  be  resorted  to, 
further  complications  might  develop.  Suppose  the  subsidiary 
company  has  been  successful  and  has  accumulated  a  goodly 
amount  of  undistributed  profit  subsequent  to  the  time  the  hold- 
ing company  acquired  its  stock  holdings  in  the  subsidiary.  How 
much  of  such  undistributed  earnings  should  be  taken  up  in 
revaluing  the  stock  holdings?  This  again  may  be  subject  to  the 
criticism  of  being  a  personal  revaluation  rather  than  one  based 
upon  actual  fact.  Also,  if  at  a  later  date  the  subsidiary  com- 
pany surplus  is  wiped  out,  the  directors  of  the  holding  company 


442 


ADVANCED  ACCOUNTING 


PARENT  VERSUS  HOLDING  COMPANIES 


443 


I 


> 


\ 


may  be  guilty  of  having  paid  dividends  out  of  capital.  Increas- 
ing the  investment  must  be  offset  by  an  increase  of  surphis,  and 
dividends  are  paid  from  surplus.  Too  great  care,  therefore, 
cannot  be  exercised  in  preparing  consolidated  statements. 

Inter-company  Accounts. — In  order  to  prepare  a  Consoli- 
dated Balance  Sheet,  all  the  relations  of  the  constituent  com- 
panies with  each  other  must  be  eliminated.  If  a  person  has  a 
dollar,  it  makes  no  difference,  so  far  as  an  account  with  liimself 
is  concerned,  as  to  what  pocket  holds  that  dollar;  but  if  he  has 
an  account  for  each  pocket,  he  must  be  careful  to  record  the 
transfer  correctly  from  one  pocket  to  another.  In  other  words, 
if  Holding  Company  owes  Subsidiary  Company  $10,000.00,  this 
fact  is  of  no  importance  from  the  standpoint  of  the  enterprise 
as  a  whole ;  what  was  formerly  a  debt  owing  by  H  Company  to 
S  Company  loses  its  value  when  the  accounts  of  the  two  com- 
panies are  brought  together. 

Capital  stock,  bonds,  accounts  receivable,  accounts  payable, 
notes  receivable,  notes  payable,  interest  receivable,  interest  pay- 
able, intercompany  sales,  rent,  loans  and  advances,  are  examples 
of  accoimts  that  may  require  elimination  in  preparing  a  Con- 
solidated Balance  Sheet,  to  the  end  that  the  relation  of  the  enter- 
prise as  a  whole  with  outside  sources  will  remain.  Any  form  of 
Balance  Sheet  which  does  not  eliminate  such  intercompany 
accounts,  as  indicated  already,  is  greatly  misleading  in  that  it 
does  not  show  the  relationship  of  the  unit  as  a  whole  to  the 
outside  public. 

Inter-company  Sales. — One  particularly  interesting  feature 
in  connection  with  int^r-company  transactions  relates  to  inter- 
company sales.  Frequently,  when  subsidiaries  carry  on  business 
as  separate  entities,  they  deal  and  contract  with  each  other  as 
independent  enterprises,  and  sales  and  transfers  between  com- 
panies are  common.  Naturally,  profits  are  booked  on  these 
transactions  which,  from  the  standpoint  of  the  organization  as 
a  whole  are  not  profits  at  all,  and  must,  from  that  point  of  view, 
be  eliminated  in  order  that  the  inventories  may  be  carried  at  a 
value  that  is  not  inflated.  A  simple  example  to  illustrate  the 
principles  involved  is  given  below: 

Problem. — A  holding  company  has  subsidiaries  consisting  of  three  man- 
ufacturing units:  Steel  mill,  tube  mill,  and  bearing  factory.    The  steel  mill 


puts  into  process  materials  in  the  amount  of  $300,000.00  at  cost;  the 
labor  and  expense  added  amount  to  $200,000.00;  the  steel  mill  sales  to  the 
tube  mill,  at  market  price,  amount  to  $350,000.00,  upon  which  there  is  a 
book  profit  of  $60,000.00.  The  tube  mill  places  these  materials  into  process 
and  adds  thereto  labor  and  expense  in  the  amount  of  $200,000.00;  the 
tube  mill  sales  to  the  bearing  factory  amount,  at  market  price,  to  $500,000.00 
upon  which  there  is  a  book  profit  to  the  tube  mill  of  $75,000.00.  The 
bearing  factory  puts  these  materials  into  process  and  adds  thereto  labor 
and  expense  in  the  amount  of  $100,000.00.  Upon  the  basis  of  the  above 
figures,  calculate  the  establishment  inventory  at  cost. 
Solution. —  -"V-— 


Steel  MiU: 

Purchases  from  outside, 
Labor  and  expense  added, 

Total  cost, 
Sales  to  tube  mill, 

Stock  on  hand. 
Book   profits,   sales  to   tube 
mill, 

Tube  Mill: 
Purchases  from  steel  mill. 
Labor  and  exi)ense  added, 

Total  cost, 
Sales  to  bearing  factory, 

Stock  on  hand. 

Book  profits,  sales  to  bearing 
factory, 

Bearing  Factory: 

Purchases  from  tube  mill, 
Labor  and  expense  added, 

Total  cost. 

Inventory  Summary: 

Steel  Mill, 
Tube  Mill, 
Bearing  Factory, 

Total, 
Comment: 


Book  Values       Eliminate         Net  Cost 


$300,000.00 
200,000.00 

$500,000  00 
290,000  00 

$210,000  00 


$300,000  00 
200,00000 

$500,000.00 
290,00000 

$210,000  00 


$  60,000.00  $60,000  00 

$350,000  00  $60,000  00  $290,000.00 

200,000  00 200,00000 

$550,000  00  $60,000.00  $490,000.00 

425,000 ■00(a)  46,325  00  378,675.00 

$125,000  00  $13,675  00  $111,325.00 


$  75,000  00 


$75,000  00 


$500,000  00  $88,675  00  $411,325.00 

100,000.00  100,000.00 

$600,00000  $88,675  00  $511,325.00 


$210,000.00 
111,325  00 
511,325.00 

$832,650  00 


(a)  Note  that  10.9  per  cent  of  the  book  cost  of  goods  made  by  the  tube 
mill  is  because  of  the  profit  of  the  steel  mill,  and  hence  not  a  true 
cost  to  the  tube  mill.     ($60,000.00  is  10.9  per  cent  of  $550,000.00). 
Further   will   be   said   concerning   intercompany   profits   under  the 
section  of  '  *  minority  interests. ' ' 


ti«i>ii»!iiwiwiiiMiiBiii 


444 


ADVANCED  ACCOUNTING 


PARENT  VERSUS  HOLDING  COMPANIES 


445 


Profits  Earned  Prior  to  Date  of  Purchase.— The  surplus  of 
a  subsidiary  company  accrued  prior  to  the  date  upon  wliich  this 
company  is  purchased  by  a  holding  company  should  not  be 
combined  with  the  surplus  accrued  subsequent  to  such  date,  for 
inclusion  upon  the  Consolidated  Balance  Sheet.  In  general,  the 
surplus  of  a  corporation  represents  the  balance  of  earnings  that 
have  accumulated  from  operations,  and  which  have  not  been  paid 
out  to  stockholders.  Since  a  surplus  accumulates  only  as  the 
result  of  operations,  the  holding  company,  prior  to  its  organiza- 
tion, cannot  have  earned  any  surplus.  Hence,  in  its  consolidated 
Surplus  account,  the  holding  company  should  carry  only  the 
surplus  accumulated  subsequent  to  the  date  upon  which  the  con- 
trolling ownership  of  the  subsidiaries  was  acquired. 

Again,  since  the  amount  paid  by  the  holding  company  for  the 
subsidiary  company  capital  stock  represents  the  former's  esti- 
mate of  its  equity  in  the  subsidiary  company,  which  is  said  to 
be  represented  by  its  capital  stock  and  surplus  at  the  moment 
of  the  take-over,  the  value  of  the  capital  stock  of  the  subsidiary 
company  must  be  eliminated  from  consideration  by  the  holding 
company;  further,  the  capital  stock  and  surplus  must  be  elimi- 
nated from  the  summarization  of  the  books  of  the  subsidiary 
company.  The  Surplus  account,  after  such  absorption,  cannot 
appear  again  as  a  surplus  item  upon  the  Consolidated  Balance 
Sheet. 

Further,  the  subsidiary  company's  surplus  as  of  the  take-over 
date  becomes  capitalized  to  the  end  that,  if  distributed  as  divi- 
dends, it  must  be  considered  in  the  holding  company  accomits 
as  reducing  the  investment  accounts.  It  is  entirely  improper 
to  accord  an  income  treatment  thereto. 

Premium  and  Discount  on  Investments. — When  a  holding 
company  purchases  the  capital  stock  of  another  company,  the 
price  paid  is  assumed  to  represent  the  former's  estimate  of  the 
value  of  the  equity  in  the  subsidiary  company's  assets.  This 
price  may  be  greater  or  less  than  the  combined  capital  stock 
and  surplus  of  the  subsidiary  company: 

1.  If  greater.  The  difference,  generally,  is  assumed  to  repre- 
sent the  value  of  the  subsidiary  company's  good-will  or 
other  assets  not  found  upon  its  Balance  Sheet.  If  these 
items  were  in  evidence  thereon,  it  would  be  natural  to 


assume  that  the  cost  of  the  capital  stock  to  the  holding 
company  would  be  equal  to  the  sum  of  the  capital  and 
surplus  of  the  subsidiary  company. 

2.  If  less.  The  difference,  generally,  is  assumed  to  represent 
the  amount  at  which  the  assets  of  the  subsidiary  company 
are  overvalued  upon  its  books.  In  many  instances,  this 
difference  is  buried  in  the  property  accounts.  Overvalua- 
tion may  be  due  to  a  deficiency  in  the  depreciation  reserves. 

The  above  presents  the  usual  viewpoint.  However,  it  seems 
necessary  to  indicate  other  possible  interpretations: 

1.  If  the  purchase  has  been  made  at  a  premium.  Hereunder, 
such  premium  may  represent: 

a.  Good-will  (as  before). 

b.  Accmnulated  surplus  assets. 

c.  Discount  upon  the  securities  of  the  holding  company 
issued  in  payment  for  securities  in  the  subsidiary 
company. 

2.  If  the  purchase  has  been  made  at  a  discount: 

a.  Good-will  inflation. 

b.  Capital  surplus,  where  actual  value  at  least  is  par,  and 
outside  conditions  responsible  for  the  discount. 

c.  Set  off  against  premium,  where  a  number  of  subsidiaries 
are  taken  over,  some  at  a  premium  and  others  at  a 
discount. 

d.  Set  off  against  subsidiary  company  deficit,  where  the 
latter  is  present.  Often  it  is  because  of  a  deficit  that 
the  purchase  can  be  made  at  a  discount. 

Good-will  on  the  Consolidated  Balance  Sheet. — Good-will 
upon  the  Consolidated  Balance  Sheet  may  be  said  to  be  the 
algebraic  sum  of  the  good-will  items  purchased  from  the  sub- 
sidiaries by  the  holding  company.  If  the  price  paid  in  cash 
or  stock  for  the  stock  of  another  company  exceeds  the  sum  of 
the  par  value  of  the  purchased  stock  plus  its  proportion  of  sur- 
plus, the  excess  represents  the  amount  to  be  charged  to  the 
Good-will  account  upon  the  Consolidated  Balance  Sheet.  No 
one  can  say  that  a  holding  company  would  be  willing  to  pay 
more  for  a  controlling  interest  in  a  constituent  company  than 
the  latter  is  worth.  The  excess  paid,  therefore,  justly  may  be 
considered  as  having  been  given  for  good-will. 


^^?^W«^9i"i*^^*" 


446 


ADVANCED  ACCOUNTING 


r  t 


Again,  if  a  purchase  price  is  paid  which  is  less  than  the  Bal- 
ance Sheet  of  the  subsidiary  shows  as  at  the  date  of  the  pur- 
chase, one  can  assume,  with  reason,  that  the  Balance  Sheet 
figures  of  the  subsidiary  are  inflated;  the  discount  involved,  as 
a  rule,  would  be  a  credit  to  the  Good-will  account  upon  the 
consolidated  statement.  If,  now,  one  should  encounter  a  con- 
dition under  which  the  total  credits  to  Good-will  account  ex- 
ceed total  charges,  a  rarity,  the  excess  credit  had  better  be 
sent  to  an  account  which,  by  its  title,  will  show  the  amount 
as  not  being  available  for  dividend  purposes.  Such  an  account 
might  be  a  ''capital  surplus"  account,  or  it  might  be  a  valuation 
account  since  its  effect  is  merely  to  offset  an  inflation  in  the 
asset  values. 

The  good-will  elements  thus  far  considered  above  relate  to 
purchase  only,  that  which  arises  at  the  time  a  purchase  is  made, 
by  charging  the  excess  of  purchase  price  over  the  book  value  of 
the  capital  stock  of  the  companies  bought.  Another  separate  and 
distinct  angle  of  the  good-will  question  arises  in  connection  with 
the  good-will  items  on  the  Balance  Sheets  of  each  of  the  sub- 
sidiary companies  as  at  the  moment  they  were  absorbed  by  the 
holding  company.  These,  as  was  noticed  in  the  last  section, 
are  merged  frequently  with  other  items  of  a  miscellaneous  char- 
acter under  the  title  of  ''property."  As  an  example  of  the 
handling  of  good-will,  consider  the  following  simple  problem 
and  solution. 

Problem. — The  H  (Corporation  purchased  all  the  capital  stock  outatandiiig 
of  the  Si,  S2,  and  S3  corporations.     The  following  facts  are  ascertained 
concerning  these  companies  purchased: 
Company         Good-will         Capital  Stock         Surplus 

SI  $20,000.00  $100,000.00 

82  10,000.00  30,000.00 

S3  none  50,000.00 


Paid  by  H 


$14,000.00 

4,000.00 

16,000.00 


$120,000.00 
40,000.00 
62,000.00 


Calculate  the  amount  of  good-will  to  be  placed  upon  the  Conuolidated 
Balance  Sheet. 

Solution. — In  solving  this  problem,  it  would  not  seem  unwise  to  take  the 
facts  as  shown  above  in  scheduled  form,  rewrite  them  and  set  out  the  coft- 
clusions  drawn  therefrom  in  separate  columns  at  the  right. 

Good-  Capital  Price  Price 

Company        will  Stock  Surplus         Paid  Over         Under 

81  $20,000  .    $100,000        $14,000    $120^    $6,000 

82  10,000  30,000  4,000        40,000      6,000 

S3  none  50,000  16,000        62,000  $4,000 


PARENT  VERSUS  HOLDING  COMPANIES 


447 


Now  that  the  facts  are  all  together,  it  is  a  fairly  simple  matter  to  determine 
the  good- will  item  for  the  Consohdated  Balance  Sheet: 
Debits: 

$20,000.00 

6,000.00     $26,000.00 

y 


SI, 
SI, 

S2, 
S2, 

Total, 
Credits: 
S3, 

Balance, 


J 


$10,000.00' 

6,000.00       16,000.00 


$42,000.00 

4,000.00 
$38,000.00 


y 

/ 


n/' 


The  Consolidated  Balance  Sheet  will  contain  an  item  of  good-will  in 
the  amount  of  $38,000.00. 

Minority  Interests  in  General.— As  a  general  proposition, 
when  a  Consolidated  Balance  Sheet  is  to  be  prepared,  the  hold- 
ing company  in  question  holds  only  a  controlling  interest  in  its 
subsidiaries  rather  than  owning  all  the  outstanding  shares  of 
stock.  Therefore,  there  usually  will  be  minority  stockholders 
who  have  a  certain  interest  in  the  subsidiary  or  subsidiaries  in 
which  they  hold  stock.  Naturally,  as  a  result,  these  persons 
should  not  be  forgotten  when  the  consolidated  statement  is  pre- 
pared; they  own  a  portion  of  the  stock  of  the  subsidiaries  and 
a  portion  of  their  surplus.  And  as  to  the  surplus,  the  portion 
owned  is  exactly  equal  to  the  percentage  their  holdings  to  the 
total  outstanding  capital  stock  of  the  subsidiaries  in  which  they 
are  interested.  This  minority  interest  in  the  capital  should  be 
set  out  in  the  Consolidated  Balance  Sheet  directly  below  the  item 
of  capital  stock  issued  and  outstanding,  as  follows: 
Minority  Stockholders'  Interest  in  Capital  Stock  of  Affiliated  CompanieB 

Capital  Stock  (par  value).  $  ^ 

Surplus,  u  I  ^ 

If  the  minority  interests  in  a  subsidiary  company  amount  to 
any  size,  a  separate  statement  should  be  prepared  thereof  to 
support  the  Consolidated  Balance  Sheet  of  the  enterprise  as  a 
whole. 

Inter-company  Sales  and  Minority  Interests.— The  principle 
to  apply  in  connection  with  inter-company  sales  was  noted 
briefly  in  an  earlier  section.  Further  elaboration  seems  neces- 
sary in  relation  to  minority  interests. 

If  the  holding  company  and  its  subsidiaries  are  regarded  as 


it 


448 


ADVANCED  ACCOUNTING 


one  enterprise,  it  is  a  simple  accounting  principle  that  sales 
from  one  unit  to  another  should  have  in  them  no  element  of 
profit.  If  this  principle  be  not  followed,  profits  will  be  antici- 
pated and  inventories  inflated.  However,  a  complication  arises 
where  the  interests  of  minority  stockholders  are  concerned.  If 
they  are  interested  only  in  one  of  the  subsidiaries,  they  have 
no  interest  in  the  enterprise  as  a  whole.  If  sales  are  made  by 
the  subsidiary  in  which  they  are  interested  to  other  subsidiaries, 
they  feel  rightfully  that  such  sales  should  be  made  at  a  fair 
profit;  if  not,  they  are  being  mistreated.  On  account  of  this 
fact,  the  system  required  to  handle  inter-company  sales,  in 
order  to  meet  two  differing  points  of  view: 

1.  That  of  the  enterprise  as  a  whole,  and 

2.  That  of  minority  interests,  must  of  necessity  be  decidedly 
elaborate  and  complicated.  All  sales  must  be  booked  at 
both  cost  and  selling  prices.    When  so  done: 

1.  A  Consolidated  Balance  Sheet  may  be  prepared  sliowing 
all  inventories  at  actual  cost,  and 

2.  Statements  may  be  prepared  for  each  subsidiary  company 
in  which  cognizance  will  be  taken  of  profits  on  inter-com- 
pany transactions. 

Where  minority  interests  are  concerned,  and  inventories  in- 
clude inter-company  profits,  the  amount  of  such  profit  may  be 
offset  on  the  Consolidated  Balance  Sheet  by  a  reserve  of  an  equal 
amount.  But  if  all  the  goods  sold  between  the  subsidiaries  have 
been  disposed  of  by  the  purchasing  subsidiary,  this  reserve  is 
unnecessary;  costs  and  sales  will  not  be  correct,  but  the  gross 
profit  will  be  correct. 

Another  point  of  interest  in  the  matter  of  inter-company  sales 
relates  to  sales  of  material  from  one  subsidiary  to  another  for 
purposes  of  construction.  From  the  viewpoint  of  the  undertaking 
as  a  whole,  this  must  be  on  a  cost  basis,  containing  no  element 
of  inter-company  profit,  even  though  the  purchasing  subsidiary 
paid  another  subsidiary  for  the  materials  on  a  cost  plus  profit 
basis.  The  amount  of  profit  involved  must  be  determined  as 
accurately  as  possible  in  order  that  it  may  be  deducted  from  the 
construction  account  in  the  Consolidated  Balance  Sheet;  this 
deduction  may  be  made  by  means  of  a  reserve  set  up  from  the 
consolidated  profit. 


PARENT  VERSUS  HOLDING  COMPANIES 


449 


Alternate  Form  of  Consolidated  Balance  Sheet.— The 
usual  form  of  the  Consolidated  Balance  Sheet,  prepared  as  will 
be  illustrated  in  a  subsequent  section,  beyond  doubt  is  the  best 
way  in  which  a  holding  company  should  set  out  its  accounts  for 
statement  purposes;  however,  it  is  not  the  only  method  that  may 
be  used.  It  is  possible  for  the  holding  company  to  carry  on  its 
Balance  Sheet  its  investment  in  a  subsidiary  merely  as  such, 
and  support  this  item  as  thereon  shown  in  either  one  of  two  ways: 

1.  Attach  a  Balance  Sheet  of  the  subsidiary  company  to  that 
of  the  holding  company,  or 

2.  Summarize  the  financial  position  of  the  subsidiary  in  con- 
crete form  directly  on  the  face  of  the  holding  company 
Balance  Sheet.    The  following  example  illustrates  the  point: 

Investment    in  the  SI  Manufacturing  Com- 
pany (65  per  cent  Interest), 


Accounted  for  as  follows: 

. , 

Land,  Buildings,  Machinery,  Equipment, 
Good-will, 

Inventories,  Accounts  and  Notes  Receiv- 
able, Cash  and  Other  Current  Assets, 
Total, 
Deduct: 


$325,000.00 


$250,000.00 
100,000.00 

300,000.00 
$650,000.00 

$150,000.00 


$500,000.00 


Current  Liabilities, 

Balance,  Net  Assets, 

65  per  cent  Interest  (as  above),  $325,000.00 

Whether  or  not  one  or  the  other  of  the  above  methods  should 
be  used  in  preference  to  the  usual  technical  form  of  statement  is, 
as  one  writer  on  accounting  has  said,  ''largely,  but  within  limits, 
a  matter  of  individual  preference."  No  one  can  deny  that  such 
a  statement  does  show  facts  and,  therefore,  so  long  as  this  be 
true,  it  may  be  permissible  to  use  it.  However,  since  accountants 
on  the  whole  lean  toward  the  technical  form  of  Consolidated 
Balance  Sheet  as  herein  discussed,  nothing  further  need  be  said 
concerning  these  possible  alternate  methods  indicated  above. 

Consolidated  Income  Statement— Content.— Basically,  the 
same  general  principles  must  be  piu-sued  in  preparing  a  Con- 
solidated Income  Statement,  the  object  of  which  is  to  set  forth 
the  operating  results  of  all  the  related  companies  as  a  unit  in 
their  relations  to  outsiders.  The  two  following  points  contain 
the  substance  of  the  entire  proposition: 


450 


ADVANCED  ACCOUNTING 


1.  Profits  transferred  from  a  subsidiary  rompany  to  the  hold- 
ing company,  by  way  of  dividends,  are  ignored. 

2.  Earnings,  expenses,  etc.,  of  all  subsidiaries  are  combined  and 
set  out  as  if  all  were  one  company. 

Illustrative  Problems — Consolidation  Balance  Sheets. — ^In 

concluding  the  discussion  of  this  chapter,  the  following  graded 

problems  and  solutions  are  included  to  illustrate  the  principles 

mentioned  above.     It  is  believed  that  a  careful  study  of  the 

solutions  submitted  will  assist  materially  in  eliminating  from  the 

mind  of  the  student  much  of  the  so-called  apparent  difficulty 

veiling  and  obscuring  this  type  of  problem. 

Problem  1. — The  H  Company,  as  of  December  31,  1920,  has  the  following 
balanpe  sheet: 
Assets: 

Fixed  assets,  $  65,000.00 

Investments: 

Miscellaneous,  » 

SI  Company: 
Capital  stock. 
Premium  on  capital  stock, 
Current  assets, 

Total  assets, 

Liabilities: 


Capital  stock, 
Fixed  liabilities. 
Current  Uabihties, 
Depreciation  reserve, 
Surplus, 

Total  liabilities, 


19,000.00 

60,000.00 

600.00 

24,650  00 

$159,150.00 

$100,000.00 

50,000.00 

612.50 

637.50 

8,000.00 

$159,150  00 


As  of  the  same  date,  the  SI  Company,  a  subsidiary  of  the  H   Company, 
has  the  following  balance  sheet: 
Assets: 

Fixed  assets,  $60,000.00 
Investments — miscellaneous,  48 ,  000 .  00 

Current  assets,  2 ,  483  68 

Due  from  S2  Company,  727.80"^ 

Total  assets, 


Liabihties: 
Capital  stock. 
Fixed  Uabilities, 
Current  Uabihties, 
Depreciation  reserve, 
Surplus, 

Total  liabilities, 


$103,211.48 

$  66,000.00 

42,000.00 

860.00 

097.24 

2,364.24 

$101,211  48 


PARENT  VERSUS  HOLDING  COMPANIES 


451 


Likewise,  as  of  the  same  date,  the  S2  Company,  a  branch  of    the    SI 
Company,  has  the  following  balance  sheet: 
Assets: 

Current  assets,  $650  00 

Liabilities: 

Current  Uabilities,  $  22 .  20 

Due  SI  Company,  627.80- 

Total  Uabilities,  $650.00 

Prepare  consolidated  balance  sheet  as  of  December  31,  1920. 

Solution  to  Problem  1. — The  first  point  to  notice  is  that,  as  between  the 
SI  Company  and  the  S2  Company,  there  is  a  home  office  and  a  branch. 
Therefore,  the  home  office  control  on  the  branch  books  should  be  in  agree- 
ment with  the  branch  control  on  the  home  office  books.  In  other  words,  a 
controUing  account  over  S2  Company  should  be  found  upon  the  books  of  the 
Si  Company,  and  this  control  should  be  in  exact  agreement  with  a  con- 
trolhng  account  upon  the  books  of  S2  Company  over  its  relationship  with 
the  Si  Company;  the  two  sets  of  books  should  articulate  one  with  the 
other.  However,  such  is  not  the  case  at  present  and,  before  proceeding 
further,  the  two  sets  of  records  must  be  placed  into  agreement,  one  with  the 
other.  If  the  branch  records  are  correct,  and  one  must  here  assume  that 
they  are,  as  well  as  those  of  the  home  office,  the  difference  between  the  two 
controls,  beyond  doubt,  represents  cash  in  transit,  or  some  other  current 
asset  in  transit,  between  the  branch  office  and  the  home  office  as  of  the  date 
of  the  balance  sheets.  The  foUowing  adjusting  entry  wiU  suffice  for  the 
books  of  SI : 

Current  Assets,  $  100 .  00 

To — Due  from  S2  Company,  $ioo .  00 

If,  in  this  particular  case,  the  item  in  question  is  cash,  the  charge  should 
not  be  made  to  the  regular  Cash  account,  since  items  in  transit  cannot  be 
considered  as  having  been  received. 

Consider  a  moment  a  principle  of  branch  accounting  which  is  applied 
in  preparing  a  ConsoUdated  Balance  Sheet,  since  branch  accounting  should 
be  famiUar  to  the  student.  If,  in  the  present  case,  a  Balance  Sheet  were  to 
be  prepared  combining  the  values  displayed  upon  both  the  books  of  the 
main  office  SI,  and  of  the  branch  office  S2,  one  would  proceed  in  accord 
with  the  elementary  principles  of  branch  accounting  by  combining  into  one 
statement  the  various  asset  and  Uability  items  now  shown  separately 
and  eUminating  thereby,  as  a  natural  result,  the  controlling  account  as 
carried  on  each  set  of  books.  In  this  connection,  the  student  is  referred, 
also,  to  the  elementary  discussion  underlying  the  operation  of  a  private 
Ledger;  commence  with  the  completed  solution  relating  to  the  opening  of 
a  private  Ledger  and  assume  that  it  is  no  longer  to  be  used.  Make  the 
entries  necessary  to  incorporate  upon  the  general  Ledger  the  information 
that  was  taken  therefrom  and  placed  in  the  private  Ledger.  When  the 
schedule  of  entries  is  complete,  note  the  cancellation  and  elimination  of 
the  two  controlling  accounts.  As  the  solution  of  the  present  problem  pro- 
ceeds, notice  the  use  of  the  same  principle  of  eUmination;  it  may  be  seen, 
also,  in  the  solutions  of  each  of  the  other  problems  included  herein.    This 


u 


I ' 


I  I 


I'd 


f 


452 


ADVANCED  ACCOUNTING 


principle  is  the  most  elementary  one  in  preparing  a  working  sheet  covering 
the  set  up  of  a  Consolidated  Balance  Sheet. 

After  the  adjusting  entry  mentioned  above  has  been  placed  upon  the 
books  of  the  Si  Company,  the  Consolidated  Balance  Sheet  called  for  may 
be  prepared  readUy.  It  appears  in  the  last  column  of  the  foUowing  working 
sheet.  This  sheet  should  be  studied  carefully  in  order  to  fix  in  mind  the 
simple  basic  principle  to  which  reference  has  been  made;  otherwise,  the 
solutions  of  the  problems  that  follow  may  not  be  comprehended. 

Problem  1— Working  Sheet 


Consolidated 

Aaaeta 

H 

m 

^ 

Total        Eliminate 

Balance 
Sheet 

Fixed  Aneta, 
Investments: 

$65,000  00 

$50,000.00 

$115,000.00 

•115,0)0  00 

Miscellaneoos, 
SI  Company: 

19,000.00 

48,000.00 

67.000.00 

67,000  00 

Capital  Stock. 

50.000.00 

60.000.00  ©$50,000.00 

Pramum  on  Capital 

Stock. 

500.00 

500.00    , 

500  00 

Current  Assets, 

24.(50.00 

2.583.68 

$650  00 

27.883.68 

27  883  68 

Due  from  S2  Company, 

627.80 
$101,211.48 

627.80  ©       627.80 
$261,011.48      $50,627.80 

Totals. 

1159.150.00 

$650.00 

1310  383  68 

Liabilities 

Capital  Stock. 

$100,000  00 

$55,000  00 

$165,000  00  ©$50,000.00 

•105  000  00/ 
02  000  00 

Fixed  Liabilities 

50,000.00 

42.000.00 

92,000  00 

Current  Liabilities, 

512.50 

850.00 

$22.20 

1.384.70 

1,384  70 

Dei»%ciation  Reserve, 

637.50 

997.24 

1.634.74 

1.634  74 

Suiplus, 

8.000.00 

2,364.24 

10,364.24 

10.364  $4X 

Due  SI  C(Hnpany, 

627. 8» 
$650,00 

627.80  ©        627.80 
$261,011.48     $50,627.80 

Totals. 

$159,150  00 

$101,211.48 

1210. 383. It 

The  technical  form  of  Consolidated  Balance  Sheet,  based  upon  the 
above  working  sheet,  has  not  been  presented.  It  contains  nothing  of  interest 
beyond  the  figures  shown  in  the  last  column  of  the  working  sheet  except 
as  to  the  item  of  Premium  on  Capital  Stock,  1500.00.  This  item  would  be 
shown  upon  the  technical  form  of  statement  in  either  one  of  the  foUowing 
two  ways,  preference  being  in  favor  of  the  first  one: 

1.  As  goodwill.     If  all  the  stock  of  a  subsidiary  is  not  owned  by  the 
holding  company,  this  method  of  treatment  predominates. 

2.  As  a  deduction  from  the  consohdated  surplus. 

Problem  2.— The  following  problem  and  its  solution  are  intended  to 
indicate  the  usual  items  requiring  elimination  in  the  preparation  of  a 
Consolidated  Balance  Sheet.  Likewise,  the  method  is  given  of  calculating 
the  item  of  good-will  therein  to  be  contained.  The  better  for  the  purpose 
in  hand,  all  items  are  shown  in  lump  sums  except  those  to  which  special 
attention  is  directed. 

The  H  Company  owns  the  stock  of  two  operating  companies,  SI  and  S2 
Just  after  the  holding  company  purchased  the  stock  of  SI  and  82,  tht 
balance  sheets  of  the  three  were  as  follows: 


( 


PARENT  VERSUS  HOLDING  COMPANIES 


453 


SI  S2 

$116,950.00     $129,740.00 


$500,000.00 
100,000.00 


J 


50, 000.00  4s 
10,000.00 


81.791.00      119,680.00 
5,000.00^ 


.00^ 


10,000.001- 


1,500 
300.00 


$600,000.00    $265,541.00    $259,420.00 


SI 


S2 


$300,000.00    $100,000.00^/ 
200,000.00     1100,000.00    $  50,000.00  ^ 


100,000.00 


Debits 
Fixed  assets. 
Investments: 
Bonds  of  affiliated  companies. 
Bonds  of  other  companies. 
Stocks  of  affiliated  compam'es 
(cost), 
Sundry  current  assets, 
Demand  notes  of  affiliated 

companies. 
Advances  to  affiUated  companies. 
Accrued  interest: 

Bonds  of  affiliated  companies. 
Bonds  of  other  companies, 
Totals, 

Credits 
Capital  stock: 

Preferred, 

Common, 
Bonds: 

Held  by  affiUated  companies, 

Held  by  others. 
Interest  on  bonds:  * 

Held  by  affiliated  companies. 

Held  by  others. 
Notes  payable: 

Held  by  affiUated  companies, 

Held  by  others. 
Advances  payable: 

AffiUated  compames. 
Sundry  current  UabiUties, 
Surplus: 

Reserved: 
Depreciation, 
Bad  debts. 
Bond  redemption. 
Free: 

.  Available  for  dividends. 
Totals, 
Required: 
Consolidated  balance  sheet. 

Solution  to  Problem  2.— The  solution  of  the  above  simple  problem  re- 
quires no  comment  beyond  a  study  of  the  foUowing  working  sheet,  since 
the  Items  to  be  eUminated  have  been  carefully  earmarked.  Note  the  cal- 
culation of  the  good-wiU  item.  The  Consohdated  Balance  Sheet  is  found  in 
the  last  column  of  the  working  sheet. 


2,000.00 

10,000.00 -^ 
15,300.00 


1,035.00 


50, 000.00 -K 
100,000.00 

1,500.00  7^ 
3,000.00 

5,000.00  tr 

10,000.00 


9,345.00 


11,300.00 

637.00 

7,500.00 


37,206.00        11,138.00 


$600,000.00    $265,541.00     $259,420.00 


f\ 


454 


ADVANCED  ACCOUNTING 


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PARENT   VERSUS  HOLDING  COMPANIES 


455 


(*)  Determination  of  Good-will 
Assets  taken  over: 
SI, 
S2, 

Total  book  value  of  assets, 


$  27,300.00 
178,845.00 


Liabilities  assumed  (toward  outsiders) : 
SI, 
S2, 

Total  book  value  of  liabilities. 

Excess  of  assets  taken  over  against  liabilities  assumed, 
Less: 

Surplus  included  in  assets  (purchased) : 
Reserved: 

51,  $  1,035.00 

52,  19,437.00     $  20,472.00 
Free  and  available: 

51,  $37,206.00 

52,  11,138.00         48,344.00 

Total  Surplus, 

Balance,  net  asset  values,  not  subject  to  dividends. 
Prices  paid  for  net  asset  values, 


$265,541.00 
259.42000 

$524,961.00 


206,145.00 
$318,816.00 


$  68,816.00 

$250,000.00 

500,000.00 


Balance,  representing  good-will,  being  the  excess  of  price  paid 


over  book  value  of  assets  not  subject  to  dividends. 


$250,000.00 


Problem  3. — ^Although  the  following  problem  and  its  solution  furnish  a 
third  illustration  of  the  preparation  of  a  simple  form  of  a  Consolidated 
Balance  Sheet,  their  use  herein  at  this  point  is  primarily  to  illustrate  the 
calculation  and  setting  out  of  the  interest  of  the  minority  stockholders. 

The  H  Company,  as  of  December  31,  1920,  acquired  90  per  cent  of  SI 
Company  stock  at  par  and  100  per  cent  of  S2  Company  stock  at  95.  In 
each  case,  the  H  Company  took  up  these  investments  into  its  accounts  at 
the  figures  given. 

On  December  31,  1920,  after  the  absorption,  the  balance  sheets  of  these 
companies  were  as  follows: 

Assets  H  SI 

$    850,000.00    $210,000.00 


Fixed  assets, 
Investments: 

51  Company  (par), 

52  Company  (95), 
Current  assets. 
Deficit, 

Total, 

Liabilities 
Capital  stock. 
Fixed  liabilities, 
Current  liabilities, 
Surplus, 

Total,  

Prepare  a  consolidated  balance  sheet. 


$  48,000.00 


90,000.00 

47,500.00 

240,000.00 


65,000.00 


88,000.00 
20,000.00 


$1,227,500.00  $275,000.00  $156,000.00 

$1,000,000.00  $100,000.00  $  50,000.00 

25,000.00  50,000.00  25,000.00 

2,500.00  50,000.00  81,000.00 

200,000.00  75,000.00 

$1,227,500.00  $275,000.00  $156,000.00 


456 


ADVANCED  ACCOUNTING 


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PARENT  VERSUS  HOLDING  COMPANIES 


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A  Co. 


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Solution  to  Problem  3.— The  solution  to  this  problem  is  presented  in  the 
following  three  portions: 

1.  ConsoUdated  working  sheet. 

2.  Calculation  of  minority  stockholders'  interest. 

3.  Consolidated  balance  sheet. 

Problem  4. — The  following  C.  P.  A.  problem  has  been  selected  as  the 
basis  for  presenting  the  final  illustration  of  the  preparation  of  a  Consolidated 
Balance  Sheet. 

The  Jones  Investment  Company  on  June  30,  X915  obtained  a  controlling 
interest  in  three  operating  companies,  viz.,  A    Co.,  B    Co.,  and  C    Co. 

The  Balance  Sheets  of  the  four  companies  as  at  June  30,  1916  are  as 
follows: 

Debits  Jones 

Investment  Co. 
Investments  in  other 

companies: 
A  Co. — 60  per  cent 

interest         (Cost 

$900,000.00), 
B  Co. — 75  per  cent 

interest  at  cost, 
C  Co. — 80  per  cent 

interest  at  cost 
Advances  to  A  Co., 
Advances  to  C  Co., 
Cash, 

Accts.  Receivable, 
Inventories, 
Plant, 
Deficit, 

Total  Debits, 

Credits 
Capital  Stock, 
Jones    Investment 

Co., 
Surplus, 

Total  Credits, 

The  Surplus  and  De- 
ficit Accounts  as 
shown  above  may 
be  analyzed  as  fol- 
lows: 

Balance  to  Jime  30, 
1915, 

Surplus  Income  6 
Months  to  Dec.  31, 
1915, 


$1,000,000.00 

600,000.00 

400,000.00 

100,000.00 

50,000.00 

50,000.00  $    100,000.00  $  10,000.00  $  50,000.00 

100,000.00      50,000.00     100,000.00 

200,000.00    100,000.00      50,000.00 

1,000,000.00    600,000.00    400,000.00 

40,000.00 


$2,200,000.00  $1,400,000.00  $800,000.00  $600,000.00 
$2,000,000.00  $1,000,000.00  $800,000.00  $400,000.00 


100,000.00 
200,000.00   300,000.00 


50,000.00 

150,000.00 

$2,200,000.00  $1,400,000.00  $800,000.00  $600,000.00 


$100,000.00   $200,000.00   $4,000.00  $100,000.00 


180,000.00   46,000.00   25,000.00 


■^\ 


458 

Six  Months  to  June 

30,  1916, 
Increase  in  value  of 

A  Co.  Stock, 
Dividends  paid  Jan. 

1916, 
Balance  June  30, 

1916, 

*Debits  indicated. 


ADVANCED  ACCOUNTING 


217,500.00        220,000.00      40,000.00*    26,000.00 

100,000.00 

217,500.00*      300,000.00*    50,000.00* 


$200,000.00      $300,000.00  $  40,000.00*$150,000.00 


Prepare  a  consolidated  Balance  Sheet  of  the  four  companies  as  at  June 
30,  1916. 

A  Statement  of  the  Consolidated  Earnings  and  Surplus  Account  for  the 
year  to  June  30,  1916  is  not  required,  but  may  be  submitted  if  desired. 

In  preparing  the  Balance  Sheet  the  following  additional  facts  should  be 
considered: 

1.  The  holding  Company  has  no  other  source  of  income  than  the  dividends 
from  the  subsidiaries,  which  have  been  taken  on  to  its  books  when 
received. 

2.  In  accordance  with  a  resolution  of  the  Board  of  Directors  of  the 
Jones  Investment  Company  the  following  entry  was  made  on  the 
holding  company  books  at  June  30,  1916. 

Dr.  Investment  in  A  Co.,  $100,000.00 

Cr.  Surplus,  100,000.00 

3.  The  inventories  of  the  A  Co.  includes  $100,000.00  of  stock  purchased 
from  B  Company  in  1916.  The  cost  of  these  goods  to  the  B  Company 
was  $90,000.00. 

4.  Part  of  the  plant  of  the  C  Company  was  built  by  the  A  Company 
in  September  and  October,  1915  at  a  cost  of  $80,000.00.  For  thi 
work  the  A  Company  charged  the  C  Company  $95,000.00. 

5.  In  February  1916,  part  of  the  equipment  of  the  B  Company  which 
was  carried  on  the  books  at  the  cost  price  of  $50,000.00,  was  destroyed 
by  fire.  The  only  entry  that  has  been  made  in  respect  to  this  loss  wiui 
to  credit  the  Plant  Account  with  the  salvage  of  $5,000.00. 

Solution  to  Problem  4. — The  first  step  would  seem  to  be  to  prepare  a 
working  sheet  and  thereon  spread  the  figures  insofar  as  they  may  be  ob- 
tained from  the  problem  itself,  namely,  down  through  the  "total"  column 
(see  working  sheet  below). 

The  second  step  would  be  to  prepare  a  schedule  of  adjusting  entries  in 
accord  with  the  facts  as  given,  and  then  spread  these  upon  the  working 
sheet  in  the  columns  provided  therefor,  keying  such  inclusion  back  against 
the  schedule.    These  adjusting  entries  are  as  follows: 


1.  Surplus, 

To — Investment  in  A  Company, 
To  write  down  the  increase  in  the 
value  of  the  A  Company  holdings. 


$100,000.00 


$100,000  00 


PARENT  VERSUS  HOLDING  COMPANIES 


$10,000.00 


459 


$10,000.00 


$15,000.00 


$15,000.00 


$45,000.00 


$45,000.00 


$177,000.00 
3,000.00 


$180,000.00 


2.  Surplus, 

To — Inventories, 

To  write  down  the  inventory  of  A 
Company  to  the  extent  of  the  dif- 
ference between  $100,000.00  and 
$90,000.00. 

3.  Surplus, 

To— Plant, 
To  write  down  the  value  of  C  Com- 
pany plant  built  by  A   Company 
from  $95,000.00  to  $80,000.00. 

4.  Surplus, 

To— Plant, 

To  write  down  the  value  of  the  B 
Company  equipment.  Cost  of  the 
equipment  was  $50,000.00  (as  de- 
stroyed) whereas,  only  $5,000.00  has 
as  yet  been  written  oflF. 

5.  Good-will, 

B  Company  Investment, 

To — ^A  Company  Investment, 

To  record  the  good-will  for  the  Con- 
solidated Balance  Sheet.  Same  is 
computed  as  below  m  separate 
schedule. 

Calculation  of  Good-will 


A  Company  investment 
(60  per  cent), 
Capital  stock, 
Surplus  6/30/15, 
Total, 

B  Company  investment 
(75  per  cent) 
Capital  stock, 
Surplus  6/30/15, 
Total, 

C  Company  investment 
(80  per  cent), 
Capital  stock. 
Surplus  6/30/15, 
Total, 
Total, 

After  these  adjusting  entries  have  been  included  upon  the  working 
statement,  the  next  step  contemplates  the  eUminations  to  be  made  on 
account  of  intercompany  transactions.  The  debit  eliminations  seem 
^U-explanatory,  requiring  no  further  comment.  On  the  credit  side  the 
tirst  elimination  relates  to  the  $150,000.00  item  of  Jones  Investment  Com- 
pany; no  question  arises  as  to  the  amount  thereof.     The  next  elimination 


Book  Value 

Cort 

Difference 
Good-wiU 

$1,000,000.00 

$720,000.00 

$900,000.00 

$180,000.00 

200.000.00 

$1,200,000.00 

$800,000.00 

603,000.00 

600,000.00 

(*)3,000  00 

4,000.00 

$804,000.00 

$400,000.00 

400,000.00 

400.000.00 

None 

100,000.00 

$500,000.00 

$1,723,000  00 

$1,900,000.00 

$177,000.00 

\ 


460 


ADVANCED  ACCOUNTING 


relates  to  capital  stock;  there  is  here  a  minority  stockholders 

which  must  be  considered,  as  below: 

Capital  stock  of  Jones  Investment  Company, 

Add:     Minority  interest  in  capital  stock  of  subsidiaries: 
A-^0  per  cent  of   $1,000,000.00,  or,     $400,000.00 
B— 25  per  cent  of      800 ,  000 .  00,  or,       200 ,  000 .  00 
C— 20  per  cent  of       400 ,000 .  00,  or,         80 ,000 .  00 


interest 


$2,000,000.00 


680,000  00 


$2,680,000.00 


Total  capital  stock  for  Consolidated  Balance  Sheet, 

$4,200,000.00  less  $2,680,000.00  equals  $1,520,000.00,  the  amount  of  the 
elimination. 

Since  only  one  item  now  remains  which  requires  adjustment,  that  of 
surplus,  the  quickest  and  easiest  way  to  complete  the  working  sheet  is  to 
balance  up  the  elimination  and  Balance  Sheet  columns  by  splitting  the  item 
of  surplus  as  shown  in  the  "total"  column.  The  working  sheet  now  is 
completed;  the  Consolidated  Balance  Sheet  is  found  in  the  last  column. 

However,  the  better  to  illustrate  the  technical  form  of  such  statement, 
especially  in  connection  with  the  determination  of  minority  stockholders' 
interest  in  capital  stock  and  suplus,  it  is  necessary  to  go  a  trifle  further  and 
present  the  Consolidated  Balance  Sheet  in  technical  form.  But  before 
this  can  be  done,  it  is  necessary  to  determine  the  interest  of  the  minority 
stockholders  in  the  surplus.     This  may  be  done  as  follows: 


1.  Surplus  balance  6/30/15. 

2.  Add:  Income  6  months  to 

12/31/15, 

3.  Balance,  Surplus  at  12/31/15, 

4.  Less:  Profit  of  A  on  plant  for  C, 

5.  Balance  adjusted  as  on  12/31/15, 

6.  Less:  Dividend  paid  on  1/1/16, 

7.  Balance  adjusted  as  on  1/1/16, 

&  Increase  (or  •decrease)  in  surplus 
6/30-12/31  (#1-7,  above), 

9.  Add:  Income  (or  *lo68)  6  mo.  to 
6/30/16, 

10.  Balance, 

11.  Less: 

Profit  of  B  on  sales  to  A, 
Fire  loss  of  B  not  on  books, 

12.  Balance  adjusted  as  on  6/30/16, 

13.  Increase  (or  'decrease)  in  surplus 

12/31/15-6/30/16, 

14.  Increase  (or  'decrease)  in  surplus 

6/30/15-6/30/16, 

15-  Distribution  of  increase: 

Jones  Investment  Com- 
pany, (60 
Minority  stockholders' 
interest,                             (40%) 

As  above  (14), 


A 

B 

C 

9200,000.00 

•  4,000.00 

$100,000.00 

180,000.00 

46,000.00 

8A.000.Q0 

S380,000.00 

$50,000.00 

$125,000.00 

15,000.00 

$365,000.00 

$50,000.00 

$139,000.00 

300,000.00 

50,000.00 

S  65.000.00 

$125,000.00 

•$135,000.00 

•$4,000.00 

$25,000.00 

220,000.00 

•40,000.00 

25,000.00 

9  85.000.00 

•$44,000.00 

10,000.00 
45,000.00 

•$95,000.00 

$00,000.00 

$85,000.00 

$50,000.00 

$220,000.00 

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1 


CHAPTER  XIV 
FIDUCIARY  STATEMENTS 

Introduction. — Before  indicating  the  purpose  of  this  chapter, 
the  term  "estate"  must  be  defined.  Webster  states  that  the  word 
refers  to  "the  degree,  nature  and  quality  of  interest  to  which 
one  is  lawfully  entitled  as  to  the  ownership  or  use  of  property; 
the  rights  held  by  one  in  regard  to  things,  as  an  absolute  estate, 
a  conditional  estate,  etc.''  An  analysis  of  this  definition,  in  the 
light  of  the  purposes  of  the  present  and  of  the  next  two  chapters, 
produces  the  following: 

1.  Assets  and  the  claims  thereagainst  properly  chargeable 
comprise  the  subject  matter  of  an  estate. 

2.  The  condition  of  an  individual  or  of  an  organization  deter- 
mines how  these  assets  and  claims  (properties)  come  into 
contact  with  accounting. 

3.  The  condition  referred  to  in  (2)  above,  in  which  present 
interest  is  centered,  is  caused  by  one  of  the  following: 

a.  The  decease  of  a  person,  or 

b.  The  incompetency  of  an  individual  or  of  an  organization 
to  hold,  to  administer,  or  to  distribute  the  estate  for  the 
benefit  of  those  therein  interested. 

Likewise,  the  term  "fiduciary  accounting"  must  be  understood 
clearly.  When  an  agent  accounts  to  his  principal,  as  does  a 
consignee  to  his  consignor,  a  fiduciary  relationship  exists,  a  rela- 
tionship under  which  one  person  is  charged  with  the  administra- 
tion and  management  of  at  least  part,  if  not  all,  of  the  affairs 
of  another.    Further  examples,  in  part,  are  as  follows: 

1.  A  guardian  charged  with  the  management  of  the  affairs  of 
a  ward. 

2.  A  lunacy  commission  charged  with  the  management  of  the 
estate  of  one  who,  under  the  law,  has  been  declared  mentally 
incompetent. 

3.  An  executor  under  a  will  charged  with  administering  and 

463 


464 


ADVANCED  ACCOUNTING 


distributing  the  estate  of 'a  decedent  in  accord  with  the 
provisions  of  the  will. 

4.  An  administrator  appointed  by  a  court  to  administer  a 
decedent's  estate  where  the  latter  died  without  making  a 
will. 

5.  An  assignee  or  receiver  charged  with  administering  proper- 
ties entrusted  to  his  care. 

Fiduciary  accounting,  therefore,  describes  the  accounting  inci- 
dent to  the  administration  of  estates,  such  administration  being 
imposed  by  a  position  of  trust  or  confidence.  As  developed  in 
this  and  in  the  next  two  chapters,  the  term,  conforming  to  the 
divisions  set  out  above,  comprehends  the  following: 

1.  Accounting  for  solvent  estates, 
a.  Those  of  decedents. 

2.  Accounting  for  insolvent  estates. 

a.  Those  which  are  only  financially  embarrassed. 

b.  Those  which  are  actually  bankrupt. 

Naturally,  all  phases  of  fiduciary  accounting  are  not  covered 
by  the  above  outline,  but  the  above  is  deemed  suflScient  for  the 
purpose  of  illustrating  the  accounting  principles  now  to  be  con- 
sidered. 

In  his  previous  work  on  consignmentn,  the  student  probably 
noticed  that  the  consignee,  by  virtue  of  having  control  of  prop- 
erty belonging  to  another,  exercised  certain  rights  thereagainst 
which  often  supplanted  those  of  the  actual  proprietor.  The  dis- 
cussion at  the  present  time  is  concerned  further  with  the  acts, 
and  the  accounting  revolving  around  such  acts,  of  those  who  are 
charged  with  the  responsibility  of  an  estate  which  actually  be- 
longs to  another.  One  will  find  that  the  prerogatives  of  these 
persons,  like  those  of  consignees,  often  replace  those  of  the  actual 
owners. 

The  purpose  of  the  present  chapter  is  to  discuss  briefly  some 
of  the  accounting  procedures  and  statements  necessary  or  re- 
quired for  recording  and  setting  out  in  a  comprehensive  manner, 
at  least  theoretically,  the  financial  transactions  relative  to  the 
administration  of  the  estate  of  a  deceased  person. 

The  writer,  primarily,  has  devoted  space  to  a  restatement  of 
principles  concerning  which  there  will  be  no  dispute,  plus  a  con- 
sideration of  some  of  the  principles  in  force  within  only  one 


FIDUCIARY  STATEMENTS:   DECEDENTS'  ESTATES      465 

jurisdiction.  Local  laws  are  at  variance,  and  the  prospective 
accountant  must  recognize  that  herein  generalization  has  been 
the  attitude  of  the  writer. 

Further  Definitions,  Terms,  and  Distinctions. — For  the 
purposes  of  the  present  chapter,  the  following  definition  of  the 
term  "estate"  is  more  satisfactory  than  the  former  one  of  Web- 
ster: ''One's  entire  property  or  possessions — property  left  over 
after  death — assets  over  liabilities,  etc." 

A  "will"  is  a  person's  solemn  declaration  in  written  legal  form, 
signed  by  such  person  (the  testator)  in  the  presence  of  witnesses, 
whereby  he  disposes  in  whole  or  in  part  of  the  property  of  which 
he  shall  be  possessed  at  the  time  of  death.  A  will  is  revocable 
during  life.  The  testator,  after  death,  is  referred  to  variously 
as  the  testator,  the  deceased,  or  the  decedent.  One  who  dies  leav- 
ing no  will  is  said  to  have  died  intestate.  An  addition  to,  or 
qualification  of,  a  will  is  called  a  codicil;  this,  as  Blackstone 
said:  "May  add  to,  take  from,  explain,  alter,  confirm,  republish 
or  revive  any  will  with  which  it  may  be  incorporated."  A 
codicil  need  not  be  physically  attached  to  the  will,  but  must,  by 
its  language,  identify  itself  with  the  will  it  is  intended  to  sup- 
plement. 

An  heir  is  one  entitled  by  law  to  succeed  to  the  real  estate  of 
a  person  dying  intestate  or  leaving  property  undisposed  of  by 
will.  Personal  property,  unless  an  heirloom,  does  not  descend 
to  heirs,  but  is  distributed,  as  by  the  administrator,  after  the 
payment  of  all  just  debts,  funeral  and  testamentary  expenses, 
among  the  next  of  kin  in  order  of  relationship.  One  to  whom 
real  estate  is  bequeathed  by  will  is  called  a  devisee ;  one  to  whom 
personal  property  is  left  is  called  a  legatee.  An  heirloom  is  a 
movable  chattel  which,  by  virtue  of  its  special  relationship  to 
the  estate,  descends  to  the  heir  with  the  lands. 

An  executor  is  a  testator's  personal  representative  named  in 
his  last  will  and  testament  to  execute  or  carry  out  its  provisions 
as  concerns  the  testator's  personal  estate.  If  a  woman  be  named 
for  carrying  out  these  duties,  she  is  called  an  executrix.  An 
executor  must  be  duly  approved  by  the  court  (Surrogate,  Probate 
or  Orphans',  as  the  case  may  be)  having  jurisdiction  where  the 
decedent  last  was  domiciled. 

If  a  person  die  intestate,  or  if  no  one  be  named  in  the  will  as 


466 


ADVANCED  ACCOUNTING 


executor,  or  if  the  executor  named  in  the  will  dies  or  cannot 
qualify,  the  power  of  appointing  someone  to  administer  the 
estate  of  the  decedent  vests  in  the  Court,  and  the  one  so  ap- 
pointed, who  may  be  either  husband,  widow,  child  or  next  of 
kin,  is  called  the  administrator  or  administratrix.  If  the  Court 
has  to  appoint  an  administrator,  because  the  will  of  the  decedent 
makes  no  provision  therefor,  the  person  so  appointed  is  known 
as  an  administrator  with  the  will  annexed.  Hereunder,  in  the 
case  of  an  administrator  (excepting  one  with  the  will  annexed), 
the  law  of  descent  in  the  particular  jurisdiction  or  locality  gov- 
erns the  settlement  of  estate  affairs,  and  the  distribution  of  the 
remaining  assets. 

A  trustee  is  one  who  holds  legal  title  to  property  subject  to  an 
obligation  to  apply  such  property  in  accord  with  the  terms  of  a 
trust  for  a  beneficiary,  or  cestui  que  trust.  In  the  case  of  a 
decedent's  estate,  the  trustee  is  named  in  the  will,  as  a  general 
proposition.  The  beneficiaries  of  an  estate  are  those  who  share 
in  the  property  of  a  decedent,  either  by  virtue  of  a  will  or  be- 
cause of  their  relationship  to  the  decedent.  Property  given 
in  trust  is  known  as  principal.  The  earnings  from  such  prin- 
cipal during  the  trust  period  are  calle<l  income.  The  trustee 
may  have  the  above  duties  in  addition  to  those  of  an  executor  or 
administrator.  A  trustee  must  use  great  care  in  connection 
with  properties  under  his  control.  All  funds  in  his  possession 
must  be  invested  and  reinvested  with  rare,  subject  to  Court 
approval.  Court  approval  governs  asset  distribution  unless 
the  will  provides  therefor.  An  Equity  or  Probate  Court  is  one 
of  competent  jurisdiction. 

In  the  administration  of  a  decedent's  estate,  there  exist  estate 
assets  which  must  be  safeguarded  carefully.  These  an?  subject 
to  liabilities  as  proved  in  Court  plus  the  costs  of  administration. 
Such  administration  is  carried  through  by  an  executor  or  by  an 
administrator  under  guidance  of  the  Court.  The  estate  of  a 
decedent,  therefore,  is  seen  to  be  safeguarded  carefully  by  the 
Court  in  order  that  the  interests  of  creditors  may  be  protected 
and  that  the  desires  and  intent  of  the  testator  may  be  carried 
out;  if  such  intent  on  the  part  of  the  decedent  be  absent,  the 
Court  must  see  that  the  local  statutory  provisions,  which  govern 
where  no  will  exists,  are  given  full  effect. 


FIDUCIARY   STATEMENTS:    DECEDENTS'   ESTATES      467 


Courts  of  Competent  Jurisdiction. — The  Courts  having 
jurisdiction  over  the  making  proof  of  wills  (called  probating), 
the  management  and  settlement  of  estates,  the  guardianship  of 
orphans,  insane  persons,  and  incompetents,  in  general,  are  known 
as  Probate  Courts.  In  New  York  the  Court  with  jurisdiction  in 
these  matters  is  called  the  Surrogate  (one  who  acts  for  another) 
Court.  In  Pennsylvania,  and  a  few  other  states,  the  designation 
given  is  that  of  Orphans'  Court.  In  Kentucky,  and  in  a  few  of 
the  southern  and  eastern  states  jurisdiction  vests  in  the  County 
Court  of  each  County. 

Where  necessary.  New  York  practice  will  provide  the  ma- 
terial of  the  present  discussion,  since  it  is  both  excellent  and 
complete. 

Duties  of  an  Executor  or  Administrator. — Since  the  duties 
of  these  two  persons  practically  are  the  same,  the  difference  be- 
tween them  being  merely  the  manner  in  which  the  appointments 
were  made,  it  seems  sufficient  to  set  out  but  one  schedule  of 
illustrative  duties.  Such  duties  are  prescribed  mainly  by  statute. 
Briefly,  they  may  be  set  out  as  follows: 

1.  See  that  the  deceased  is  properly  buried,  the  funeral  ex- 
penses to  be  those  that  are  necessary  and  reasonable  con- 
sidering the  social  status  of  the  decedent. 

2.  Have  the  will  probated  and  take  out  letters  testamentary, 
paying  such  expenses  as  are  necessary  for  the  cost  of  pro- 
bate and  the  securing  of  certified  copies  of  the  proceedings. 
If  the  will  be  contested,  the  executor  must  require  the 
parties  to  be  benefited  by  the  will  to  secure  him  against  the 
suit  costs  in  case  of  failure. 

3.  Prepare  an  inventory  of  all  the  personal  property  of  the 
estate,  have  this  inventory  appraised,  and  file  same  with 
the  Surrogate  Court. 

4.  Realize,  collect,  and  conserve  the  estate  assets. 

5.  Advertise  for  claims  against  the  estate. 

6.  Pay  the  debts  in  order  of  precedence  as  established  by 
law  or  by  the  Court. 

7.  Distribute  the  balance  of  the  property  according  to  the 
terms  of  the  will,  setting  aside  any  trust  funds  called  for 
by  the  will. 

8.  Convert  the  surplus  of  the  personal  estate,  if  any,  into  cash 


468 


ADVANCED  ACCOUNTING 


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and  distribute  this  cash  among  the  next  of  kin  in  accord 
with  the  statutes  of  distribution. 
9.  Keep  such  accounts  as  will  show  how  the  estate  has  been 
administered. 

10.  Account  to  the  Court  of  his  appointment,  whenever  called 
upon,  presenting  a  report  showing  the  receipts  and  dis- 
bursements, and  the  balance  available  for  distribution,  in 
accord  with  the  Court's  order. 

11.  Apply  for  discharge  upon  a  final  accounting  within  the 
time  prescribed  by  statute  for  tlie  completion  of  the  ad- 
ministration. 

Will  Admitted  to  Record  or  Probate.— A  will  may  be  said 
to  be  admitted  to  record  when  it  has  been  duly  probated,  i  e., 
established  by  the  testimony  of  subscribing  witnesses,  or  such 
of  them  as  are  alive,  and  letters  testamentary  ordered  and  de- 
creed. A  copy  of  the  order  so  made  is  recorded  in  the  state 
and  county  in  which  the  will  was  admitted  to  probate.  The 
following  steps  usually  are  involved  in  the  admission  of  a  will 
to  probate: 

1.  Filing  of  a  petition  asking  the  Court  to  admit  the  will  to 
probate. 

2.  Notification  of  all  interested  persons  that  on  a  day  certain 
the  will  is  to  be  considered. 

3.  Hearing  or  trial  at  which  proof  of  the  will's  legality  must 
be  offered. 

4.  Court  decision  as  to  whether  or  not  the  will  offered  for 
probate  is  valid. 

Letters  testamentary  refers  to  an  instrument  issuing  from  a 
Court  of  competent  jurisdiction  authorizing  the  executor  to  take 
charge  of  and  administer  a  testator's  estate.  If  a  person  dies 
intestate,  the  instrument  in  writing,  issued  by  the  Court  to  the 
administrator  authorizing  him  to  administer  the  intestate  estate 
is  designated  as  letters  of  administration.  If  a  will  exists,  but  no 
one  has  been  named  therein  as  executor,  the  instrument  referred 
to  above  authorizing  a  person  to  administer  the  estate  would 
be  known  as  the  letters  of  administration  with  will  attached. 
A  bond  can  be  required  of  the  executor  or  administrator  by  the 
Court,  although  in  the  case  of  an  executorship  the  testator  may 


FIDUCIARY  STATEMENTS:   DECEDENTS'  ESTATES      469 

state  no  bond  shall  be  required,  in  which  event  the  Court  will 
not  request  one. 

Estate  Assets.— The  first  duty  of  an  executor  is  to  collect  the 
assets  (personal  property)  of  the  estate  with  which  he  is  charged 
and  file  an  inventory  thereof  with  the  Court.  Some  states  re- 
quire the  inventory  to  be  filed,  as  in  New  York;  others  permit 
the  filing,  and  others  are  silent  on  the  point.  Whatever  the  law 
may  be  in  any  particular  state,  it  is  safe  practice  to  prepare 
an  inventory  and  file  it  with  the  Court,  because  the  inventory 
prima  facie  fixes  the  number  and  the  value  of  the  estate  assets. 
In  such  case,  should  anyone  dispute  the  inventory,  the  burden 
of  proof  rests  on  this  other,  not  on  the  executor  as  would  be  the 
case  where  no  inventory  is  filed. 

The  inventory  in  most  states  should  include  only  personal 
property  of  the  deceased,  because  the  real  property  passes  with- 
out the  intervention  of  the  executor.  The  inventory  items  would 
be  valued  by  appraisers  appointed  by  the  Court  who,  under  oath, 
the  oath  being  inserted  in  the  statement  of  the  inventory,  will 
appraise  the  assets  honestly  and  impartially  to  the  best  of 
their  knowledge  and  ability,  stating  each  item  in  detail  with 
the  value  thereof  in  dollars  and  cents,  distinctly,  in  figures  op- 
posite to  the  articles  respectively. 

Unless  the  law  of  the  executor's  state  specifically  requires  him 
to  file  with  the  inventory  a  list  of  the  debts  due  by  the  deceased, 
such  debts  should  not  be  mentioned. 

The  New  York  statute  requires  the  written  appointment  of  two 
dismterested  appraisers  who  are  appointed  upon  application  of 
the  executor  or  administrator  and  states  that  the  '^following  per- 
sonal property  shall  be  included  in  the  inventory: 

1.  Leases  for  years;  lands  held  by  the  deceased  from  year  to 
year;  and  estates  held  by  him  for  the  life  of  another  per- 
son. 

2.  The  interest  remaining  in  him,  at  the  time  of  his  death,  in 
a  term  of  years  after  the  expiration  of  any  estate  for  years 
therem,  granted  by  him  or  any  other  person. 

3.  The  interest  in  lands  devised  to  an  executor  for  a  term  of 
years  for  the  payment  of  debts. 

4.  Things  annexed  to  the  freehold,  or  to  any  building  for  the 


470 


ADVANCED  ACCOUNTING 


FIDUCIARY  STATEMENTS:   DECEDENTS'   ESTATES     471 


purpose  of  trade  or  manufacture,  and  not  fixed  into  the  wall 
of  a  house  so  as  to  be  essential  to  its  support. 

5.  The  crops  growing  on  the  land  of  the  deceased  at  the  time 
of  his  death. 

6.  Every  kind  of  produce  raised  annually  by  labor  and  culti- 
vation, except  growing  grass  and  fruit  ungathered. 

7.  Rent  reserved  to  the  deceased  which  had  accrued  at  the 
time  of  his  death. 

8.  Debts  secured  by  mortgages,  bonds,  notes,  or  bills;  accounts, 
money,  and  bank  bills,  or  other  circulating  medium,  things 
in  action,  and  stock  in  any  corporation  or  joint-stock  asso- 
ciation. 

9.  Goods,  wares,  merchandise,  utensils,  furniture,  cattle,  pro- 
visions, moneys  unpaid  on  contracts  for  the  sale  of  lands, 
and  every  other  species  of  personal  property  not  herein- 
after excepted.  Things  annexed  to  the  freehold,  or  to  a 
building,  shall  not  go  to  the  executor,  but  shall  descend 
with  the  freehold  to  the  heirs  or  devisees,  except  such  fix- 
tures as  are  mentioned  in  the  fourth  sub-division  of  this 
section.  The  right  of  an  heir  to  any  property,  not  enumer- 
ated in  this  section,  which  by  the  common  law  would 
descend  to  him,  is  not  impaired  by  the  general  terms  of 
this  section. 

"The  inventory  must  contain  a  particular  statement  of  all 
bonds,  mortgages,  notes  and  other  securities  for  the  payment  of 
money  belonging  to  the  deceased,  known  to  the  executor  or  ad- 
ministrator; with  the  name  of  the  debtor  in  each  security,  the 
date,  the  sum  originally  payable;  the  indorsements  thereon,  if 
any,  with  their  dates  and  the  sum  which,  in  the  judgment  of  the 
appraisers,  is  collectible  on  each  security;  and  of  all  moneys, 
whether  in  specie  or  bank  bills,  or  other  circulating  medium 
belonging  to  the  deceased,  which  have  come  to  the  hands  of  the 
executor  or  administrator,  and  if  none  have  come  to  his  hands, 
the  fact  shall  be  stated  in  the  inventory.  * 

"Duplicates  of  the  inventory  must  be  made  and  signed  by  the 
appraisers,  one  of  which  must  be  retained  by  the  executor  or 
administrator,  and  the  other  returned  to  the  surrogate  within 
three  months  from  the  date  of  the  letters.  On  returning  such 
inventory,  the  executor  or  administrator  must  take  and  subscribe 


an  oath,  indorsed  upon  or  annexed  to  the  inventory,  stating  that 
the  inventory  is  in  all  respects  just  and  true,  that  it  contains  a 
true  statement  of  all  the  personal  property  of  the  deceased  which 
has  come  to  his  knowledge,  and  particularly  of  all  money,  bank 
bills  and  other  circulating  medium  belonging  to  the  deceased,  and 
of  all  just  claims  of  the  deceased  against  him,  according  to  the 
best  of  his  knowledge." 

The  duplicate  of  the  inventory  retained  by  the  executor  or 
administrator  becomes  the  basis  for  the  accounts  he  keeps. 

Again,  in  New  York,  if  a  man  dies  leaving  a  widow  or  minor 
child  or  children,  certain  articles  are  not  to  be  deemed  assets, 
but  must  be  included  and  stated  in  the  inventory  of  the  estate 
without  being  appraised: 

1.  One  sewing  machine,  and  stoves  put  up  or  kept  for  use 
by  his  family. 

2.  Family  pictures  and  school  books,  and  books  not  exceed- 
ing the  value  of  fifty  dollars  which  were  part  of  the  family 
library. 

3.  Certain  animals,  and  all  necessary  provisions  and  fuel  to 
keep  the  surviving  members  of  the  family  sixty  days. 

4.  Certain  articles  of  furniture  and  equipment,  as  wearing 
apparel,  beds,  clothing,  ornaments,  not  exceeding  $150.00 
in  value. 

5.  Sundry  household  items  as  furniture,  provisions,  etc.,  in  the 
discretion  of  the  appraisers,  to  the  value  not  exceeding 
$150.00. 

If  a  married  woman  die,  leaving  surviving  her  a  husband,  or 
a  minor  child  or  children,  the  same  articles  and  personal  prop- 
erty shall  be  set  apart  by  the  appraisers  with  the  same  effect 
for  the  benefit  of  such  husband,  or  minor  child  or  children. 

Certain  exceptions  are  found  in  every  state,  and  as  to  them 
the  state  laws  must  be  studied  carefully. 

In  conclusion,  it  should  be  noted  the  items  to  be  inventoried 
will  vary  somewhat  under  the  laws  of  the  different  states,  but 
in  every  case  all  property  coming  into  the  custody  of  the  executor 
or  administrator  should  be  inventoried  and  appraised.  Care 
should  be  observed  not  to  overstate  values,  for  if  the  amount  real- 
ized be  less  than  the  amount  appraised,  it  may  appear  that 


472 


ADVANCED  ACCOUNTING 


the  executor  or  administrator  has  been  careless.  This  inven- 
tory, as  said  above,  becomes  the  basis  for  the  executor's  or  ad- 
ministrator's accounts  and  the  basis  upon  which  he  must  account 
to  the  Court. 

Collection  and  Care  of  Assets.— After  the  inventory  is  filed, 
the  executor  or  administrator  should  proceed  at  once  to  secure 
possession  of  the  estate  assets.  If  he  believes  certain  assets  are 
m  possession  of  persons  who  refuse  to  deliver  them  to  him,  he 
should  commence  '^discoverj^  proceedings"  to  secure  them. 

An  executor  or  administrator  is  responsible  for  the  preserva- 
tion of  the  estate  assets  in  his  possession,  and  to  this  end  he 
must  exercise  the  same  care  toward  them  that  an  ordinarily 
prudent  man  would  exercise  in  the  care  of  his  own  property  of  a 
similar  nature  under  similar  business  conditions. 

He  should  deposit  cash  belonging  to  the  estate  in  a  reputable 
bank,  doing  so  in  the  name  of  the  estate,  as  'The  Estate  of  A, 
by  B,  Executor,"  and  he  should  be  careful  never  to  mingle  his 
own  funds  with  those  of  the  estate.  In  general,  he  is  to  collect 
and  distribute  estate  cash,  not  to  invest  it. 

All  payments  should  be  made  by  check,  and  duplicate  receipts 
should  be  secured  for  each  such  payment,  one  for  the  Court,  and 
one  to  be  retained  by  himself.  In  New  York,  every  payment  of 
twenty  dollars  or  more  must  be  covered  by  a  properly  receipted 
voucher.  Items  not  exceeding  twenty  dollars  in  amount  must  be 
supported  by  his  own  uncontradicted  oath,  stating  positively  the 
fact  of  payment,  and  specifying  when  and  to  whom  payment  was 
made.  The  total  amount  of  such  allowed  items  shall  not  exceed 
$500.00. 

Estate  Debts.— In  New  York,  the  executor  or  administrator, 
at  any  time  after  the  granting  of  his  letters,  may  insert  a  notice 
once  a  week  for  six  months  in  such  newspaper  or  newspapers 
printed  in  the  county  as  the  Surrogate  directs,  requiring  all  per- 
sons having  claims  against  the  deceased  to  exhibit  the  same 
with  the  vouchers  therefor,  to  him,  at  a  place  to  be  specified 
m  the  notice,  at  or  before  a  day  therein  named,  which  must  be 
at  least  six  months  from  the  day  of  the  first  publication  of  the 
notice.  Satisfactory  vouchers  may  be  required  in  support  of  any 
claim  presented  and  the  affidavit  of  the  claimant  that  the  claim 
IS  justly  due,  that  no  payments  have  been  made  thereon,  and 


FIDUCIARY  STATEMENTS:   DECEDENTS'   ESTATES     473 

that  there  are  no  offsets  against  the  same  to  the  knowledge  of 
the  claimant. 

If  a  suit  be  brought  on  a  claim  which  is  not  presented  to  the 
executor  or  administrator  within  six  months  from  the  first  pub- 
lication of  such  notice,  the  latter  shall  not  be  chargeable  for  any 
assets  or  moneys  that  he  may  have  paid  in  satisfaction  of  any 
lawful  claims,  or  of  any  legacies,  or  in  making  distribution  to 
the  next  of  kin  before  such  suit  was  commenced. 

It  is  presumed  that  after  a  lapse  of  six  months  all  claims  will 
have  been  presented,  and  the  executor  or  administrator  may 
thereafter  pay  all  proved  claims,  and  distribute  any  remaining 
balance. 

States  may  differ  as  to  particulars  covering  the  above  points, 
but  the  underlying  plan  is  similar  everywhere;  namely,  that 
claims  must  be  presented  after  published  notice,  within  a  cer- 
tain period  of  time,  and  that  after  the  lapse  of  such  time  the 
executor  or  administrator  may  assume  all  estate  debts  have 
been  proved  and  act  accordingly. 

In  New  York,  every  executor  and  administrator  must  proceed 
with  diligence  to  pay  the  debts  of  the  deceased  according  to 
the  following  order: 

1.  Debts  entitled  to  a  preference  under  the  laws  of  the  United 
States. 

2.  Taxes  assessed  on  the  property  of  the  deceased  previous  to 
his  death. 

3.  Judgments  docketed,  and  decrees  entered  against  the  de- 
ceased according  to  the  priority  thereof  respectively. 

4.  All  recognizances,  bonds,  sealed  instruments,  notes,  bills 
and  unliquidated  demands,  and  accounts. 

Preference  shall  not  be  given  in  the  payment  of  a  debt  over 
other  debts  of  the  same  class,  except  those  specified  in  the  third 
class.  A  debt  due  and  payable  shall  not  be  entitled  to  a  prefer- 
ence over  debts  not  due. 

Estate  Bookkeeping.— The  bookkeeping  necessary  to  record 
properly  the  financial  transactions  of  an  executor  or  adminis- 
trator of  an  estate  depends  chiefly  upon  the  nature  and  upon  the 
value  of  the  property  of  which  he  assumes  control  and  the  terms 
and  provisions  of  the  will  or  wishes  of  the  decedent,  so  far  as 
they  can  be  ascertained.    While  the  accounting  forms  and  meth- 


474 


ADVANCED  ACCOVKTING 


FIDUCIARY  STATEMENTS:   DECEDENTS'  ESTATES      475 


ods  to  be  used  may  be  prescribed  by  law,  no  special  system 
of  bookkeeping  is  necessary  and  the  executor  is  at  liberty  to 
keep  his  books  in  any  manner  he  likes,  provided  that  at  all 
times  he  can  make  a  proper  accounting  therefrom  in  conformity 
with  legal  requirements  underlying  the  presentation  of  the  finan- 
cial facts  relative  to  the  estate.  The  legal  requirements  govern 
the  contents  of  the  statements,  not  their  form. 

Reports  to  the  Court  always  must  be  accompanied  by 
vouchers;  and  receipts  and  disbursements  of  principal  must  be 
shown  clearly  separated  from  those  of  income.  The  estate  books 
should  be  arranged  so  that  these  particulars  may  be  recorded 
easily  and  the  resultant  facts  ascertained  readily.  For  an  ordi- 
nary estate,  the  following  records  would  be  illustrative: 

1.  Journal.  The  opening  entries  in  this  record  should  be  the 
appraiser's  report;  the  assets  would  be  debited,  the  liabili- 
ties credited,  and  an  account  with  the  estate  credited  for 
the  balance  in  order  to  place  the  books  in  equilibrium. 
Subsequent  entries  would  consist  of  all  items  other  than 
cash,  as  revenues,  expenses,  etc.,  separated  carefully  as  to 
principal  and  income.  Further,  the  Journal  may  be  used 
as  a  memorandum  book  for  the  entry  of  any  important 
facts  that  take  place  during  the  period  of  administration. 

2.  Cash  Book.    This  record  may  be  ruled  about  as  follows: 


Debit  side: 
Date 

Explanation 
Total 

Principal  Receipts 
Income  Receipts 
Deposits 


Credit  side: 
Date 

Explanation 
Checks 

Number 

Amount 
Income  Debts 
Principal  Debts 


3.  Ledger.  This  record  should  contain  all  the  real  and  nominal 
accounts  of  the  estate  diflferentiated  as  above  indicated, 
and  the  accounts  with  heirs,  beneficiaries,  annuitants,  etc., 
showing  amounts  paid  and  due  them  from  income  and  prin- 
cipal. 

4.  Bank  account  (with  accompanying  check  book,  j)ass  book 
and  bank  statements). 

5.  Duplicate  vouchers. 

figures  comprising  the  estate  inventory  as  shown  by  the 


In  a  small  estate,  double  entry  books  of  account  sometimes 
are  not  used.  The  estate  assets  and  liabilities  are  set  out  in 
inventory  form,  only  the  cash  transactions  being  entered  upon 
the  books  of  account.  For  such  an  estate,  the  following  might 
be  sufficient: 

1.  Asset  inventory. 

2.  Liability  inventory. 

3.  Bank  account  (with  accompanying  check  book,  pass  book, 
and  bank  statements). 

4.  Duplicate  vouchers. 

5.  Cash  book. 

Even  though  the  above  simple  method  of  keeping  estate  ac- 
counts may  be  used  in  perhaps  the  majority  of  cases,  no  one 
well  can  say  that  the  records  would  not  be  kept  to  better  advan- 
tage by  using  the  double  entry  principle.  In  fact,  there  is  no 
reason  why  an  executor  or  administrator  should  not  keep  his 
records  by  double  entry.  To  do  so,  means  greater  convenience, 
and  permits  of  their  being  audited  readily.  In  the  case  where  a 
trusteeship  enters  into  consideration, — where  property  is  held 
by  one  as  trustee  for  the  benefit  of  another  (the  cestui  que  trust) 
for  a  term  of  years, — double  entry  records  always  should  be 
used. 

Such  accounts  should  be  opened  in  the  Ledger  as  will  facili- 
tate the  preparation  of  the  schedules  to  be  furnished  when  ac- 
counting to  the  Court.  Ledger  explanations  should  be  complete 
and  full  as  to  details,  so  that  the  accounting  may  be  made 
directly  from  the  face  of  the  Ledger  without  need  of  referring 
to  any  other  data.  The  Ledger  would  be  opened  by  Journal 
entry  debiting  the  Inventory  and  crediting  the  Estate  or  Corpus 
account.  Each  asset  mentioned  in  the  inventory  will  be  given 
a  separate  account,  the  value  therefor  being  the  amount  entered 
in  the  appraisal  inventory  as  filed  in  Court. 

As  the  assets  are  converted  into  cash,  the  Cash  account  will 
be  charged  and  the  particular  asset  account  credited.  If  an 
asset  realizes  more  than  the  appraised  value,  the  excess  should 
be  credited  to  a  separate  account  as  Increase  of  Principal  (or 
Corpus).  This  account  is  an  adjunct  of  the  estate  account  and 
provides  a  means  of  accounting  for  increases  in  asset  values  and 
for  any  assets  discovered  after  the  original  inventory  was  pre- 


476 


ADVANCED  ACCOUNTING 


I    ^J 


i 


II 


i 


pared.  If  an  asset  realizes  less  than  the  appraised  value,  the 
difference  between  sales  price  and  inventory  value  sliould  be 
charged  to  a  special  account  as  Decrease  of  Principal  (or  Cor- 
pus). This  account,  also,  is  part  of  the  estate  account  and 
forms  the  basis  of  a  separate  schedule.  Administration  expenses 
may  be  chargeable  to  a  Testamentary  Expenses  account,  and  a 
separation  must  be  made  between  those  chargeable  against  prin- 
cipal and  those  chargeable  against  income. 

As  liabilities  are  liquidated  by  cash  payments,  the  liability 
accounts  are  debited  and  cash  credited.  Income  as  collected 
should  be  credited  to  a  special  income  account,  this  being  the 
basis  of  a  separate  schedule.  A  personal  account  would  be  opened 
for  each  legatee  to  which  are  charged  all  advances  made.  Each 
legatee  account  is  credited  with  the  amount  of  the  legacy,  the 
estate  account  being  charged.  After  the  legal  time  has  elapsed 
durmg  which  the  presentation  of  claims  of  creditors  may  be 
made,  if  the  estate  be  solvent,  the  legatees  may  be  paid  the 
amounts  coming  to  them  under  the  will.  If  there  be  no  will,  the 
distribution  will  be  made  to  the  heirs-at-law  or  to  the  next-of- 
kin,  in  accordance  with  the  governing  statute.  Legatees'  pay- 
ments form  a  separate  schedule. 

Principal  (Corpus)  Versus  Income.— It  was  noted  above 
that  the  two  essential  elements  in  the  accounting  of  executors 
are: 

1.  Principal  (corpus). 

2.  Income. 

The  principal  is  represented,  with  but  few  exceptions,  by  the 
original  inventory  of  the  estate  plus  subsequent  increases  therein 
as  governed  by  the  law  specifying  what  is  principal.  The  total 
of  these  amounts  is  subject  to  deduction  for  all  decreases  in 
principal  due  to  sales  of  assets  for  less  than  their  appraised  value, 
and  for  all  legitimate  expenses  of  administration  and  debts 
chargeable  against  principal. 

Income  is  represented,  with  but  few  exceptions,  by  the  in- 
creases in  the  estate  subsequent  to  the  death  of  the  decedent. 
It  is  difficult  sometimes  to  determine  whether  any  particular 
amount  of  cash  received  is  to  be  credited  to  principal  or  to  in- 
come. The  distinction  is  especially  important  where  the  ele- 
ment of  trusteeship  enters  into  the  problem.    And  to  this  end. 


FIDUCIARY  STATEMENTS:   DECEDENTS'  ESTATES     477 

some  space  will  be  devoted  later  to  this  important  topic,— to 
a  discussion  of  some  of  the  various  questions  in  accounting  aris- 
ing out  of  this  legal  relation,— specifically,  the  relation  of  life 
tenant  and  remainderman. 

Executor's  Accounting  to  the  Court.— The  executor  or 
administrator  prepares  a  final  statement  for  judicial  settlement, 
in  which  are  shown  the  items  and  amounts  chargeable  to  him, 
the  disbursements  therefrom,  and  the  remaining  balance.  The 
form  of  such  accounting,  where  statutes  or  Courts  permit,  is  a 
simple  one  called  ''charge  and  discharge."  In  New  York,  such 
an  accounting  is  considerably  more  elaborate,  being  decidedly 
cumbersome,  seemingly,  as  compared  to  the  simple  charge  and 
discharge  method. 

In  New  York,  judicial  settlement  of  the  account  of  an  executor 
or  administrator  may  be  compelled  by  the  Surrogate  under  the 
following  cases: 

1.  After  the  expiration  of  a  year  from  the  time  letters  were 
issued. 

2.  Where  letters  issued  have  been  revoked,  or  where,  for  any 
reason,  powers  have  been  revoked. 

3.  Etc. 

Executors  and  administrators  must  make  and  file  a  report 
with  the  jurisdictive  Court  at  least  once  a  year  and,  as  before 
stated,  these  reports  must  be  made  in  approved  form. 

An  executor  or  administrator  may  file,  as  in  the  office  of  the 
Surrogate,  an  account  for  the  purpose  of  disclosing  his  acts, 
the  amount  of  funds  in  his  hands,  and  the  condition  of  the 
estate,  without  there  being  a  judicial  settlement.  Such  an  ac- 
counting is  termed  an  intermediate  accounting.  In  New  York 
an  executor  or  administrator,  at  any  time,  voluntarily  may  file 
an  intermediate  account,  and  the  vouchers  in  support  thereof; 
further,  under  certain  specific  cases,  the  Surrogate  may,  in  his 
discretion,  make  an  order,  requiring  an  intermediate  account  to 
be  rendered. 

A  judicial  settlement  may  be  required  in  New  York  of  an 
executor  or  administrator  after  a  year  has  expired,  after  letters 
have  been  revoked,  etc.  The  form  of  judicial  settlement  state- 
ment used  in  New  York  consists  of  a  number  of  schedules,  let- 
tered from  A  to  G,  inclusive,  which  are  smnmarized  in  a  portion 


I 


478 


ADVANCED  ACCOUNTING 


of  the  report.     In  sum  and  substance,  such  statement  is  as 
follows: 

Schedules 

A.  1.  Personal  property  sold  and  particulars  of  sale. 

2.  Debts  of  decedent  collected. 

3.  Moneys  received  for  interest,  rents,  dividends,  etc. 

B.  1.  Statement  showing  debts  uncollected  and  reasons  therefor. 

2.  Statement  of  property  remaining  unsold. 

3.  Statement  showing  increase  or  decrease  in  value  of  property. 

C.  Moneys  paid  for  funeral  and  testamentary  expenses. 

D.  Payment  to  creditors  of  claims  allowed. 

E.  Moneys  paid  to  legatees,  widow,  or  next  of  kin. 

F.  Names  and  addresses  of  persons  entitled  as  legatees 

G.  Miscellaneous  expenses— statements  of  executors  as  to  facts,  etc. 

Skeleton  Form  of  Report 

The  body  of  the  report  should  read  substantially  as  follows: 
I  charge  myself: 

With  amount  of  inventory,  |  a 

With  increase,  as  per  schedule  A,  |  ^ 

With  income  as  per  schedule  A,  |  ^ 

Total  charges,  g  a 

I  credit  myself: 

With  funeral  and  testamentary  expenses  paid  as  per 

schedule  C,  ^  ^ 

With  payments  to  creditors  as  per  schedule  Q^  $  ^ 

With  legacies  paid  as  per  schedule  E,  |  ^ 

With  commissions  and  other  charges  deducted  as 

per  schedule  F,  |  ^ 

Total  credits,  p  ^ 

Balance  (Undistributed  aasets  on  hand) : 

Debts  uncollected,  |  ^ 

Property  unsold,  $  ^  •  ^ 


Commissions. — Executors  and  administrators,  and  trustees 
are  compensated  for  their  trouble  in  administering  the  work 
under  their  charge.  It  may  be  that  such  compensation  is  left  to 
the  discretion  of  the  Court,  or  it  may  be  that  the  matter  is  regu- 
lated by  statute.  In  New  York,  executors  are  allowed  5  per  cent 
on  the  first  $1,000.00,  21/2  per  cent  on  the  next  $10,000.00,  and 
1  per  cent  on  the  balance  of  the  total  estate  received  and  dis- 
tributed. This  would  be  over  and  above  expenses.  If  there  be 
more  than  one  executor,  the  amount  would  be  apportioned 
among  them  on  the  basis  of  service  rendered. 


FIDUCIARY  STATEMENTS:   DECEDENTS'  ESTATES      479 

In  the  matter  of  computing  commissions,  the  following  formula 
is  illustrative: 

1.  Beginning  inventory  plus  increase  therein  equals  gross  prin- 
cipal received. 

2.  Gross  principal  received  less  losses  equals  net  principal  re- 
ceived. 

3.  Net  principal  received  plus  gross  income  received  equals 
total  estate  received  and  distributed. 

It  is  on  this  last  amount  that  the  commission  should  be  com- 
puted. Again,  instead  of  computing  the  percentages  as  shown 
above,  where  the  estate  received  and  distributed  exceeds 
$11,000.00,  the  following  short  cut  calculation  may  be  used: 

1.  One  per  cent  of  the  amount  received  and  distributed  plus 
$190.00. 

Final  Duties. — After  the  final  accounting  has  been  approved, 
all  Ledger  accounts  but  cash  and  those  representing  assets  on 
hand  must  be  closed  into  the  estate  account.  The  total  undis- 
tributed assets  on  hand  equals  the  credit  in  the  estate  account. 

The  annual  report  must  be  made  as  required  for  fiduci- 
aries under  the  Federal  Income  Tax  Law.  The  executor  or  ad- 
rainistrator  before  paying  off  the  legacies  should  protect  himself 
as  regards  inheritance  taxes.  These  taxes  follow  the  property, 
but  the  executor  or  administrator  is  liable  for  their  collection. 
If  a  legatee  does  not  pay  him  the  amount  assessed,  he  should 
hold  out  same  when  paying  over  the  legacy. 

Illustrative  Problem — Application  of  Double  Entry  Prin- 
ciples.—The  following  problem  illustrates  the  double  entry 
principle  applied  to  a  set  of  executor's  transactions.  The  entries 
are  self-explanatory.  The  Ledger  accounts  are  omitted  as  being 
unnecessary. 

Froblem.— John  Smith  died  July  1,  1919,  leaving  an  estate  which  con- 
sisted of  the  following: 

Cash  on  hand,  |     1,000.00 

Bank  overdraft,  2,625.00 

Loan  to  Theodore  Brown,  39  OOO  00 

Interest  at  6  per  cent,  payable  January  1  and  July  1. 

Interest  paid  to  January  1,  1919. 
Life  insurance  policy,  5  qqq  qq 

$1,200.00  was  borrowed  upon  this  policy  four  years  ago. 

No  interest  has  ever  been  paid  on  this  loan. 
Preferred  stock  of  the  Automatic  Drill  Press  Co.,  100,000.00 


V 


u 


:■{ 


I 


480 


ADVANCED  ACCOUNTING 


286,000.00 


First  mortgage  5  per  cent  bonds  of  the  Southern  Alcohol 

Distilleries, 

Interest  is  payable  March  1  and  Sept.  1. 
Sundry  liabilities,  1 1 ,  000 .  00 

The  accrued  interest  upon  the  loans  and  bonds  has  not  been  included 
above.  A  cash  dividend  upon  the  stock  in  the  Automatic  Drill  Press 
Company  was  declared  prior  to  the  death  of  John  Smith  but  was  not 
received  until  afterward. 

Its  amount  was,  $10,000.00 

The  funeral  expenses  were,  1 ,  100 .  00 

The  will  provided  that  the  net  income  was  to  be  paid  to  Smith's  widow. 

The  interest  due  July  1,  1919,  on  the  loan  to  Theodore  Brown  was  re- 
ceived July  2,  1919.  The  insurance  policy  was  collected  on  August  1, 
1919,  the  amount  of  the  loan  plus  accrued  interest  being  deducted  therefrom 
in  settlement.  The  bonds  were  sold  on  October  I,  for  $295,000.00.  All  the 
liabilities  were  paid,  and  the  income  collected  up  to  and  including  December 
31,  1920,  was  paid  over  to  the  widow  of  Smith. 

Draft  all  entries  necessary  to  give  expression  to  the  above  trannactions. 

Solution  to  Problem. — The  entries  for  the  above  transactions  are  as  follows: 


Cash  on  hand. 

Loan  to  Theodore  Brown, 

Life  insurance  policy: 

Face  value. 

Less  Loan  made,        $1 ,  200 .  00 


1,000.00 
30,000.00 


$5,000.00 


Accrued  interest 

7/1/15-8/1/19 


240.00       1,440.00 


Preferred  stock,  Automatic  Drill  Press  Co., 

First  mtge.  5  per  cent  bonds — Southern  Alcohol 

Distilleries, 

Dividend  account — ^Automatic  D.  P.  Co., 

Accrued  interest: 

Loan  to  Theodore  Brown, 

First  mtge.  bonds. 

To — Bank  overdraft. 

Sundry  habilities. 

Estate  of  John  Smith, 

To  record  assets  and  liabilities  as 

at  Smith's  death,  July  1,  1919,  as 

shown  by  detailed  inventory  on 

file. 
Cash, 

To — ^Accrued  interest,  Loan  to  T.  Brown, 

To  record  receipt  of  interest  on  loan 
to  Brown  on  July  2,  1919. 
Funeral  expenses. 

To— Cash, 

To  record  funeral  expenses  paid. 


3,560.00 
100,000.00 

286,000.00 
10,000.00 

900.00 
4,766.67 


I    2,625  00 

11,000  00 

422,601  67 


$900.00 


$900  00 


$1,100.00 


•1,100.00 


FIDUCIARY  STATEMENTS:   DECEDENTS'  ESTATES      481 


Cash, 

To — Dividend  account.  Automatic  D.  P.  Co., 
To  record  dividend  received. 
Bank  overdraft. 
To— Cash, 

To  record  payment  of  above  liability. 

Cash, 

To — Accrued  interest,  first  mtge.  bonds. 
Interest  received. 

To  record  receipt  of  interest  due  on 
September  1. 
Buyer  of  first  mtge.  5  per  cent  bonds — So. 
Alcohol  Dist., 

To — First   mtge.    5  per    cent    bonds — So. 
Alcohol  Dist., 

Interest  received, 

To  record  sale  on  October  1,  of  all 
bonds  on  hand  for  $295,000.00  plus 
accrued  interest  to  date. 
Cash, 

To — Buyer  of  first  mtge.  5  per  cent  bonds — 
So.  Alcohol  Dist., 

To  record  cash  received  from  sale  of 
above  bonds. 
First  mtge.  5  per  cent  bonds — So.  Alcohol  Dis- 
tilleries, 

To — Profit  on  realization  of  assets, 

To  record  transfer  of  profit  from 
sale  of  bonds  to  a  separate  profit 
accoimt. 
Interest  on  life  insurance  loan, 

Cash, 

To — ^Life  insurance  policy. 

To  record  payment  of  insurance 
policy.  The  interest  charge  above 
is  6  per  cent  on  the  loan  of  $1,200.00, 
for  1  month,  from  July  1,  1919, 
to  August  1,  1919. 

Interest  received. 
To — Income  account. 

To  record  transfer  of  income  items  to 
a  separate  income  account. 

Income  account. 
To— Cash, 

To  record  payment  to  widow  of  all 
income  collected  to  December  31, 
1920. 


$10,000.00 


$2,625.00 


$7,150.00 


$296,191.67 


$296,191.67 


$9,000.00 


$        6.00 
3,554.00 


$3,575.00 


$3,575.00 


$10,000.00 


$2,625.00 


$4,766.67 
2,383.33 


$295,000.00 
1,191.67 


$296,191.67 


$9,000.00 


$3,560.00 


$3,575.00 


$3,575.00 


.( 


482 


ADVANCED  ACCOUNTING 


ur. 


r'. 


1 

i 


il 


n 


Sundry  liabilities. 
To— Cash, 

To  record  payment  of  sundry  lia- 
bilities. 


$11,000.00 


111,000.00 


$1,106.00 


$9,000.00 


$1,100  00 
6.00 


$9,000  00 


Estate  of  John  Smith, 
To — Funeral  expenses, 

Interest  on  life  insurance  loan, 
To  close. 
Profit  on  realization  of  assets, 
To — Estate  of  John  Smith, 
To  close. 

Illustrative  Problem — Charge  and  Discharge  Statement 
with  Schedules.— The  following  C.  P.  A.  problem  and  solution 
illustrates  the  more  technical  form  of  charge  and  discharge 
statement  with  accompanying  schedules  as  required  in  New 
York. 

Problem.— John  Doe  died  January  15,  19 — ,  leaving  a  small  estftte,  and 
in  his  will  made  Richard  Roe  his  executor.  The  will  provided  that  a 
legacy  of  $5,000.00  should  be  paid  to  Mary  Doe,  sister  of  the  testator,  and 
that  the  residuary  estate  should  go  to  testator's  wife  and  two  daughters, 
share  and  share  alike. 

The  estate  consisted  of  the  following: 
Cash  in  Dime  Savings  Bank,  %      348  50 

One  month's  salary  (due  testator  from  his  employer),  250.00 

10  Union  Pacific  Railroad  Company's  first  mortgage  5  per  cent 

gold  bonds  of  $1,000.00  each,  10,000  00 

One  first  income  bond,  Central  Railroad  of  Georgia,  1,000.00 

Demand  note  of  John  Smith,  100  00 

At  his  death  the  testator  owed  two  months'  rent  $50.00,  Acker,  Merrall  & 
Condit,  household  supplies,  $81.50. 

The  appraiser  appointed  by  the  surrogate  inventoried  all  securities  and 
accounts  due  the  estate  at  their  face  value. 

The  executor  received  $348.50  from  the  Dime  Savings  Bank,  with  $14.25 
interest.  He  sold  the  Union  Pacific  bonds  at  102  and  two  months '  interest, 
the  Central  of  Georgia  income  bond  for  $875.00  flat,  and  paid  M.  J.  Senior, 
undertaker,  $541.00  for  funeral  expenses,  Arnold,  Constable  &  Co.,  $185.00 
for  mourning  apparel  of  widow  and  children.  He  also  paid  for  legal  and 
other  expenses  incidental  to  the  probating  of  the  will,  $125.00.  John 
Smith  was  bankrupt,  and  his  note  proved  to  be  worthless.  The  executor 
deducted  his  commission  and  distributed  the  funds  of  the  estate  according 
to  the  terms  of  the  will. 

From  the  above  statement  of  facts  prepare: 

a.  The  executor's  inventory  of  the  estate. 

b.  The  executor's  summary  statement  and  schedules  for  prctsentation 
to  the  surrogate's  court  in  final  accounting. 

c.  A  statement  of  the  amount  of  comnussiuxis  to  which  the  executor 
is  entitled. 

d.  A  statement  of  the  amount  paid  to  each  beneficiary. 


FIDUCIARY  STATEMENTS:   DECEDENTS'   ESTATES      483 

Solution  to  Problem: 

Copy  of  the  inventory  of  the  Estate  of  John  Doe,  who  died 

January  15,  19 — ,  filed — — ,  19 — 


Cash  in  Dime  Savings  Bank, 
One  month's  salary  due  testator  from  employer 
10  Union  Pacific  Railway  Company  first  mort- 
gage 5  per  cent  gold  bonds  of  $1,000.00  each,  par 
value,  1  First  income  bond,  Central  Railroad 
of  Georgia, 
Demand  note  of  John  Smith, 


Schedule  A 


Nominal 

Value 

%      348.50 
250.00 


Appraised 

Value 

$       348.50 
250.00 


10,000.00       10,000.00 


1,000.00 
100.00 


1,000.00 
100  00 


$11,698.50     $11,698  50 


Inventory 

Debts  collected: 
$      348.50    Cash  in  Dime  Savings  Bank, 
250 .  00     Salary  collected,  1  month, 
Sales  of  property: 
10,000.00     10  Union  Pacific  Railroad  bonds  at 
102    and    interest    (interest    below), 
1,000.00     1    First  income  bond.  Central   Rail- 
road of  Georgia,  at  87  1/2  flat, 

$11,598  50 

Income  received: 

Deposit  in  Dime  Savings  Bank, 
Union    Pacific    Railroad   bonds,    2 
months,  at  5  per  cent  on  $10,000, 


Realized 


Profit 


348.50 
250.00 


10,200.00  $200.00 
875.00 


$11,673.50  $200.00 

14.25 

83.33 
$11,771.08 


(Signed)  Richard  Roe,  Executor, 

Estate  of  John  Doe,  deceased. 

Schedule  B 


Debts  not  collected: 

Demand   note   of   John   Smith,    uncollected   as 

maker  is  bankrupt,  and  note  considered  worthless 
Loss  on  realization  of  inventory  values: 

Appraised  value  of  First  income  bond  of  Central 

Railroad  of  Georgia, 
Amount  realized, 


$100.00 


$1,000.00 
875.00 


$125  00 

$225  00 

(Signed)  Richard  Roe,  Executor, 

Estate  of  John  Doe,  Deceased 


484 


i| 


ADVANCED  ACCOUNTING 


Funeral  expenses: 

Undertaker's  bill,  M.  J.  Senior, 
Other  expenses: 

Probate  expenses, 


Schedule  C 


$541.00 
125  00 


Money  paid  creditors: 
Rent,  two  months, 
Household  supplies.  Acker,  Merrall  &  Condit, 


S666  00 
(Signed)  Richard  Roe,  Executor, 

Estate  of  John  Doe,  Deceased. 
Schedule  D 


150  00 
81  50 


Payments  to  legatees: 
Money  advanced  widow  and  children, 
Mary  Doe,  sister,  bequest. 
Widow,  1/3  residuary  estate,  per  will, 
Daughter,  1/3  residuary  estate,  per  will. 
Daughter,  1/3  residuary  estate,  per  will. 


$131  50 
(Signed)  Richard  Roe,  Executor,  " 

Estate  of  John  Doe,  Deceased. 
Schedule  E 


$1,826.95 
1,826  96 
1,826.96 


$       185  00 

6,000  00 


•307.71 


5.480.87 

$10.665  87 
(Signed)  Richard  Roe,  Executor. 

Estate  of  John  Doe,  Deceased. 
Schedule  F 
Names  and  addresses  of  beneficiaries  (n^  given  in  problem). 

Schedule  G 
Other  facts  relating  to  the  estate: 

Richard  Roe,  executor  for  commission. 
Estate  principal,  per  inventory,  $1 1 ,  698 .  50 

Increase-Sale  of  Union  Pacific  Rail- 
road bonds,  20000 

Total  charge  account  of  principal,     $11,898^50 
Deduct: 

Debts  not  collected, 

Schedule  B,  $100.00 

Loss  on  sale  of  First  in- 
come bond  Central  Rail- 
road of  Georgia,  125  00  225 .  00 

Net  principal  received. 

Income  received, 


$11,673.50 
97.58 


$11,771  08 


FIDUCIARY  STATEMENTS:  DECEDENTS'  ESTATES     485 


Commissions: 
5  per  cent 
on  first, 
2$  on  next, 
1  per  cent 
on  balance, 


$  1,000.00 
10,000.00 

771.08 
$11,771.08 


$  50.00 

250.00 

7.71 

$307.71 

$11,698.50 
200.00 

$11,898.50 


(Signed)  Richabd  Roe,  Executor, 

Estate  of  John  Doe,  Deceased. 

Summary  Statement  of  the  Executor  Richard  Roe,  of  the  Estate  of  John 

Doe,  who  died  January  15,  19 — ,  filed  ,  19 — , 

I,  Richard  Roe,  Executor,  charge  myself  as  follows: 
Amount  of  inventory. 
Increase,  as  shown  in  Schedule  A, 

I  credit  myself  as  follows: 

Losses,  as  shown  in  Schedule  B,  $225 .  00 

Expenses,  as  shown  in  Schedule  C,  666 .  00 

Creditors'  payments,  as  shown  in  Schedule  D,     $131 .50 
Showing  balance  of  principal, 

As  to  income,  I  charge  myself  with : 

Income  received,  that  is.  interest,  as  shown  in 
Schedule  A, 

Leaving  net  value  of  estate, 
I  credit  myself  with: 

Advances  and  final  payments  made  to  legatees 
in  accordance  with  terms  of  the  will,  as  shown 
in  Schedule  E, 

Commissions  deducted  by  myself,  as  shown  in 
Schedule  G, 


1,022  50 
$10,876.00 


97.58 
$10,973  58 


$10,665.87 

307.71 
$10,973  58 
The  said  schedules,  which  are  severally  signed  by  me,  are  part  of  this 
account. 

Respectfully  submitted, 

Richard  Roe,  Executor. 
Comment: 

1.  Technical  phraseology  of  the  legal  form  has  been  omitted. 

2.  The  information  found  in  the  question  as  worded  is  somewhat  insuflS- 
cient  to  work  out  an  absolutely  inteUigent  solution  so  far  as  the  proper 
apportionment  of  sums  between  capital  and  income  is  concerned. 
A  more  or  less  arbitrary  treatment  of  certain  items  has  been  followed; 
for  example,  it  is  possible  to  treat  the  $185.00  advanced  to  the  widow 
and  children  for  mourning  apparel  as  falling  under  Schedule  C  instead 
of  in  Schedule  E.  But  without  further  information,  the  item  seems 
correct  as  placed. 


486 


ADVANCED  ACCOUNTING 


Trusts.— A  trust  is  a  right  of  property,  real  or  personal,  held 
by  one  party  for  the  benefit  of  another.  These  two  parties  are 
designated  as  follows: 

1.  Trustee:  the  person  who  holds. 

2.  Beneficiary:  the  one  for  whose  benefit  the  right  is  held. 
This  person  is  known,  also,  as  the  cestui  que  trust. 

As  a  rule,  three  persons  are  concerned  in  a  trust: 

1.  The  one  who  created  it.  This  is  the  owner  who  held,  origi- 
nally, both  legal  and  equitable  title  to  the  right  in  ques- 
tion. 

2.  The  trustee  to  whom  the  legal  title  is  given. 

3.  The  beneficiary  who  has  the  equitable  rights  to  the  bene- 
fits of  the  property. 

The  right  of  the  beneficiary  is  in  the  trust,  the  obligation  of 
the  trustee  results  from  the  trust,  and  the  right  held  is  the 
subject  matter  of  the  trust.  No  one  alone  is  the  trust;  but  to- 
gether they  constitute  the  trust. 

The  law  fixes  firmly  the  rights  and  liabilities,  or  duties,  of 
the  parties  to  a  trust.  The  relation  of  an  agent  to  his  prin- 
cipal savors  of  a  trust,  but  this  relationship,  as  well  as  many 
other  legal  relationships,  in  whole,  are  not  in  exact  agreement 
therewith.  Even  though  a  fiduciary  relationship  exists  between 
an  agent  and  his  principal,  such  relationship  is  not  of  the  same 
type  as  that  of  a  trustee  to  his  beneficiary.  An  agent  acts  for 
a  principal,  binding  the  latter;  a  trustee,  when  he  acts  only 
binds  himself. 

Trusts  may  be  classified  in  a  number  of  ways,  of  which  the 
following  are  illustrative: 

1.  Active  as  opposed  to  passive  (or  dry). 

2.  Executed  as  contrary  to  executory. 

3.  Express  as  against  implied. 

4.  For  value  versus  voluntary. 

In  an  active  trust,  the  trustee  has  some  duty  to  perform  In 
a  passive  trust,  the  trustee  is  not  bound  to  the  performance  of 
any  duty;  by  force  of  such  a  trust,  merely  the  legal  title  to 
some  right  rests  in  the  trustee.  An  executed  trust  is  one  fully 
declared  so  that  nothing  further  need  be  done  to  make  it  com- 
plete. An  executory  trust  requires  some  further  act  to  com- 
plete the  intention  of  the  creator;  for  example,  A  conveys  in  trust 


FIDUCIARY  STATEMENTS:   DECEDENTS'  ESTATES      487 

to  B,  to  convey  to  C.  An  express  trust  is  created  by  an  express 
voluntary  act  of  the  creator;  if  the  subject  matter  be  real  estate, 
the  trust  must  be  created  in  writing.  A  trust  for  value  is  one 
based  upon  a  valuable  consideration  as  distinguished  from  one 
created  out  of  the  goodness  of  heart. 

Duties  of  Trustees.— Anyone  can  be  a  trustee,  but  no  one 
should  be  who  is  not  capable  of  making  a  valid  contract.  Cor- 
porations, known  as  trust  companies,  hold  themselves  out  to  the 
public  as  ready  to  act  as  trustees.  If  a  trust  be  created,  but  for 
some  reason  or  other  there  is  no  trustee  selected,  a  Court  of 
Equity  will  appoint  some  one  to  act  in  that  capacity. 

The  powers  of  a  trustee  are  all  sufficient  to  carry  out  the  pur- 
poses for  which  the  trust  was  created.  When  one  accepts  such 
ofiice,  he  must  carry  out  the  trust,  except  when  relieved  from  so 
doing  either  by  all  the  beneficiaries  or  by  returning  all  the  prop- 
erty to  the  Court.  A  trustee  is  in  duty  bound  to  carry  out  the 
trust  in  the  manner  prescribed,  using  the  property  entrusted  to 
his  care  and  governing  his  actions  in  relation  thereto  as  would 
a  prudent  man  under  like  circumstances,  exercising  due  diligence. 
He  cannot  make  personal  profit  out  of  the  trust  property,  and  he 
must  be  careful  not  to  mingle  trust  properties  with  his  own. 

Trustees'  acts  always  are  subject  to  supervision  by  a  Court 
of  Equity.  For  that  reason,  he  should  keep  accounts  of  the 
trust  estate  and  he  should  be  prepared  to  render  an  accounting 
whenever  required  to  do  so.  His  accounts  must  be  kept  in  such 
a  way  that  no  obscurities  are  therein  seen.  If  anything  is  found 
to  be  of  a  doubtful  nature,  he  will  be  held  accountable  therefor. 
He  is  charged  with  the  trust  estate  and  he  is  held  liable  therefor 
until  he  has  discharged  himself  properly  therefrom. 

Relation  Between  Work  of  Executor,  Administrator,  and 
Trustee.— An  executor  or  administrator  is  a  court  officer;  a 
trustee  is  not  a  court  officer.  A  trustee  disposes  of  definite  prop- 
erty in  a  specific  way ;  an  executor  or  administrator  disposes  of 
general  property  in  a  general  way.  A  trust  may  be  created  by 
a  living  person  as  well  as  under  a  will.  But  the  accounting  in 
connection  with  either  viewpoint  is  essentially  the  same. 

The  basic  principle  to  remember  is  that,  under  any  one  of 
the  three,  some  person  is  charged  with  certain  properties  and 
he  must  account  to  a  Court  therefor  by  means  of  properly  kept 


488 


ADVANCED  ACCOUNTING 


FIDUCIARY   STATEMENTS:   DECEDENTS'  ESTATES     489 


records  in  order  that  he  may  discharge  himself  eventually  from 
the  personal  liability  assumed  when  he  charged  himself  with 
their  values. 

Another  point  to  remember  is  that  an  executor  or  adminis- 
trator may  act,  also,  as  trustee.  When  this  is  the  rase  the 
executor  or  administrator  should  be  careful  to  discharge  himself 
from  properties  over  which  he  acts  as  executor  or  administrator 
before  he  charges  himself  with  them  as  trustee. 

Life  Tenant  Versus  Remainderman. — The  last  three  sec- 
tions of  this  chapter  revolve  around  the  distinctions  between 
principal  and  income.  And  these  distinctions  must  of  necessity 
be  those  which  affect  the  rights  of  a  life  tenant  as  against 
those  of  a  remainderman.  They  arise  primarily  in  investment 
accounting  in  cases  where  the  funds  out  of  which  a  life  tenant's 
income  is  to  be  paid  have  been  invested  in  securities  after  the 
decedent's  death. 

In  the  last  analysis,  however,  it  should  be  remembered  that 
regardless  of  technical  differentiations  as  between  principal  and 
income,  the  intent  of  the  testator  is  all  important,  this  being 
the  governing  factor.  If  the  Court  can  ascertain  what  such  in- 
tent was,  the  will  will  be  interpreted  in  accord  therewith  regard- 
less of  whether  such  intent  does  or  does  not  conform  to  scientific 
distinctions. 

A  life  tenant  is  a  person  who  for  his  natural  life  enjoys,  or 
persons  who  for  their  natural  lives  enjoy,  or  for  a  specified  period 
or  periods,  or  until  the  happening  of  an  event  or  events,  the  net 
income  or  real  or  personal  estate,  or  both.  A  life  tenant  is  en- 
titled to  enjoy  only  the  net  income  from  property  or  investments, 
or  both,  for  a  specified  period,  usually  for  his  natural  life. 

A  remainderman  is  a  person  in  whom  an  estate  shall  absolutely 
vest,  on  the  termination  of  the  rights  of  the  life  tenant.  Herein 
the  term  includes  any  person  or  persons  in  whom  property  shall 
vest,  on  the  termination  of  the  rights  of  the  life  tenant  therein. 

It  is  usual  and  best,  where  a  life  estate  is  created  in  personalty, 
or  partly  in  personalty  and  partly  in  realty,  to  appoint  a  trustee 
to  hold  and  manage  the  estate  during  the  life  tenancy,  and  on  the 
termination  of  the  life  tenancy  to  convey,  or  transfer  and  de- 
liver, the  then  principal  of  the  estate  to  the  remainderman. 

Whether  there  is  a  trustee  or  no  trustee  (in  the  latter  case  as 


where  an  estate  is  created  as  to  realty,  a  trustee  is  not  absolutely 
necessary  to  hold  the  realty  for  the  period  of  enjoyment  of  the 
life  tenant,  because  the  latter  cannot  sell  and  convey  the  whole 
estate  without  the  remainderman  joining  in  the  conveyance) 
the  rights  as  to  the  enjoyment  of  the  estate  of  the  life  tenant 
and  remainderman  are  governed  by  the  same  general  legal  prin- 
ciples, except  as  to  the  question  of  estate  management.  If  there 
be  a  trustee,  management  vests  in  the  latter;  where  there  is 
none,  and  there  is  no  specified  restriction  as  to  such  estate  man- 
agement, the  management  vests  in  the  life  tenant  during  his 
period  of  enjoyment. 

Even  though  the  management  of  an  estate  is  in  a  life  tenant, 
he  cannot  lease  the  estate  beyond  the  time  of  his  own  enjoyment 
and  he  cannot  encumber  more  than  his  own  interest  unless  he  is 
given  express  authority  so  to  do. 

A  widow's  dower  in  her  deceased  husband's  realty,  the  courtesy 
of  a  widower  in  his  deceased  wife's  realty,  and  homestead  rights 
of  a  widow  and  minor  children  in  a  deceased  husband's  and 
father's  realty  are  life  estates  or  estates  for  years  created  by 
operation  of  law;  all  other  life  estates  or  estates  for  years  exist 
only  by  express  provisions  under  instruments  given  when  the 
grantor  is  living  or  under  wills. 

A  life  tenant,  during  the  continuance  of  his  interest  in  a  trust 
estate,  is  entitled  to  enjoy  the  exact  legal  net  income  of  the 
estate,  and  nothing  more  or  less.  The  remainderman,  on  the  ter- 
mination of  the  life  estate,  is  to  receive  the  exact  legal  prin- 
cipal of  the  estate,  and  nothing  more  or  less.  Therefore,  a  trustee 
must  keep  his  accounts  so  that  all  items  of  income  will  be  shown 
separately  from  all  legal  items  of  principal,  and  must  prorate 
items  legally  between  principal  and  income  when  such  appor- 
tionment is  required  by  law  or  by  Court  order.  This  distinction 
at  times  may  be  difficult  to  maintain,  yet  the  trustee  must  keep 
his  accounts  legally  accurate,  not  merely  accurate  as  to  amounts 
of  items  but  accurate  in  conformity  to  the  rules  of  law. 

The  rights  of  beneficiaries  in  a  trust  estate  are  governed  basic- 
ally by  the  express  terms  of  the  instrument  or  will  creating 
the  trust,  so  far  as  such  terms  are  within  the  law;  and  where 
there  are  no  proper  and  express  terms,  the  general  rules  of  law 
control.    The  general  rules  of  law  will  control,  also,  where  by 


490 


ADVANCED  ACCOUNTING 


m 


4  '''' 

ii 


reason  of  changed  conditions,  the  express  terms  can  no  longer 
be  carried  out.  In  all  cases  of  doubt,  the  trustee,  for  his  own  pro- 
tection, should  go  to  Court  and  have  tlie  Court  pass  upon  the 
matter.  If  the  trustee  should  overpay  the  life  tenant  during 
the  trust,  or  on  the  termination  of  the  trust  should  overpay 
the  remainderman,  he  may  be  held  personally  liable  even  though 
he  may  have  acted  in  entire  good  faith  in  distinguishing  between 
items  chargeable  or  credited  to  income  or  chargeable  or  credited 
to  principal  in  his  trust  accounts.  The  trustee  must  know  his 
accounts  are  correct  in  principle  and  in  detail;  otherwise,  he  is 
liable. 

Distinctions  Relating  to  Income. — In  distinguishing  between 
principal  and  income,  the  following  two  general  rules  are  ad- 
vanced: 

1.  Be  governed  basically  by  the  distinction  followed  in  mer- 
cantile accounting  between  capital  charges  and  revenue 
charges. 

2.  Know  the  local  law  when  working  on  any  specific  case. 
Ordinary  costs  and  expenses  in  the  routine  administration  of 

the  trust  estate  should  be  paid  out  of  income.  Such  expenditure 
does  not  add  to  the  value  of  the  property  or  assets  of  the  trust 
estate. 

Illustrative  income  distinctions  are  indicated  below: 

1.  Rent  of  safety  deposit  boxes  in  which  to  keep  estate  securi- 
ties and  papers. 

2.  Express  charges  on  securities  sold  which  have  to  be  for- 
warded, or  which  have  to  be  forwarded  for  collection. 

3.  Transfer  tax  when  sale  of  securities  is  liable  to  such  tax. 

4.  Cost  of  forwarding  and  collecting  interest  coupons  and  notes. 

5.  Postage  and  stationery  for  use  in  connection  with  business 
matters  concerning  the  trust. 

6.  Attorney's  fees  in  connection  with  services  affecting  the 
trust  estate  and  not  involving  the  existence  of  the  trust  or 
title  to  trust  assets. 

7.  Commissions  of  agents  employed  to  collect  rents  from  trust 
realty. 

8.  Services  of  accountants,  bookkeepers  and  clerks  engaged  in 
attending  to  trust  business. 


FIDUCIARY  STATEMENTS:   DECEDENTS'   ESTATES      491 

9.  Services  of  workmen  engaged  in  caring  for  and  repairing 
trust  properties. 

10.  Court  costs  in  connection  with  hearing  and  auditing  annual 
or  interim  accounts  of  trustee  filed  with  Court. 

11.  Planting,  caring  for,  harvesting,  selling  and  shipping  crops, 
where  land  is  cultivated  by  trustee. 

12.  Caring  for  and  feeding  cattle,  etc.,  and  the  cost  of  selling 
and  shipping  the  increase  of  live  stock,  cattle  and  sheep 
of  the  trust  estate. 

13.  Commissions  of  trustee  from  time  to  time  at  the  legal  rate 
on  disbursements  of  income  of  trust  estate.  This  does  not 
include  perhaps  commissions  on  disbursements  of  principal. 

14.  Cost  of  repairs  upon  realty  improvements.  If  the  life  ten- 
ant should  die  before  such  payments  are  made,  the  cost 
should  be  borne,  nevertheless,  by  him  because  the  remain- 
derman is  entitled  to  receive  the  premises  free  of  any 
charges  imposed  thereon  by  the  life  tenant. 

15.  Annual  general  taxes  assessed  and  due  and  payable  against 
the  real  and  personal  property  of  the  estate,  and  any  annual 
special  taxes  for  sprinkling  or  other  purposes  not  considered 
as  being  improvements.  If  there  is  no  income  out  of  which 
they  can  be  paid,  the  trustee  must  advance  the  payment 
temporarily  out  of  the  principal.  Taxes  never  should  be 
allowed  to  become  delinquent.  Subsequently,  when  a  net 
income  has  been  produced,  the  advance  out  of  principal 
should  be  restored. 

16.  When  the  life  tenant  dies  during  any  current  taxable  year, 
his  estate  should  be  charged  with  an  amount  proportionate 
to  the  time  he  has  enjoyed  the  estate  income  during  that 
year.  This  is  true  whether  taxes  are  payable  before  or  after 
the  death  of  the  life  tenant. 

17.  When  directed,  the  trustee  must  insure;  otherwise,  he  may 
insure,  as  against  fire  and  wind  storm.  All  insurance  pre- 
miums paid  are  chargeable  against  income.  If  insurance  is 
collected,  and  the  trustee  does  not  deem  it  advisable  to 
restore  the  destroyed  property,  as  where  improvements  are 
destroyed,  the  proceeds  so  collected  belong  to  the  principal 
of  the  estate. 

18.  Rents  payable  after  the  death  of  the  deceased,  and  due  to 


492 


ADVANCED  ACCOUNTING 


; 


him  whether  partly  or  practically  entirely  for  a  period  of 
time  prior  to  date  of  death  are  collectible  in  favor  of  the 
life  tenant  pro  rata.  Subsequent  rents  are  considered  as  in- 
come. During  the  continuance  of  the  life  tenancy  the  life 
tenant  is  entitled  to  the  net  rents  accruing  to  the  date  of  his 
death,  and  the  lost  rent  is  adjustable  to  the  date  of  his 
death,  so  that  his  legal  representative  will  receive  any 
amount  accrued  and  not  collected  by  the  trustee  at  the 
death  of  the  life  tenant,  or  collected  and  not  disbursed  by 
the  trustee.  Rent  accrues  from  day  to  day  in  favor  of  the 
life  tenant. 

19.  The  trustee,  out  of  the  income  of  the  trust  estate,  must  keep 
all  properties  in  as  good  order  as  when  the  same  came  to  the 
trustee  under  the  instrument  or  will  creating  the  tnist,  with- 
out deterioration  except  ordinary  wear  and  tear.  Material 
depreciation  affects  the  estate  principal. 

20.  Interest  payment  on  mortgages  which  encumber  estate 
properties  are  chargeable  against  income. 

21.  If  a  trustee  holds  corporate  stock  for  a  life  tenant,  and  re- 
mainderman, dividends  declared  out  of  current  earnings  and 
out  of  undivided  profits  and  surplus  earned  during  the 
existence  of  the  trust  belong  to  the  life  tenant  as  income.  If 
a  dividend  declared  and  paid  is  unusually  large,  the  trustee 
is  at  once  put  on  inquiry  to  ascertain  if  part  thereof  does 
not  accrue  to  the  estate  corpus.  The  separation  may  be 
hard  to  determine,  and  when  so,  the  Court  should  be  ap- 
pealed to  for  guidance,  as  to  how  the  particular  dividend 
shall  be  credited,  in  whole  or  in  part,  to  income  or  corpus, 
or  both.  It  makes  no  difference  whether  the  dividends  be 
all  cash,  or  all  corporate  securities,  or  part  of  each. 

22.  When  corporate  stock  is  sold,  and  where  the  corporate  capi- 
tal, undivided  profits,  and  surplus  at  the  time  of  sale  are 
larger  than  the  amount  at  the  beginning  of  the  trust,  it 
is  assumed  a  higher  price  was  realized  for  the  stock  than 
would  have  been  the  case  had  there  not  been  this  increase; 
and  a  fair  proportion  of  the  proceeds  of  the  sale,  represent- 
ing the  increase  in  surplus  and  undivided  profits  in  respect 
of  the  shares  sold,  should  be  considered  as  accumulated 
earnings  belonging  to  the  estate  income;  the  remaining  por- 


FIDUCIARY  STATEMENTS:   DECEDENTS'  ESTATES     493 

tion  is  part  of  corpus.     On  this  point,  the  trustee  should 
seek  Court  advice. 
23.  Generally,  all  interest  collections  on  demand  and  on  secured 
principal  notes,  or  on  bonds,  held  at  par  as  an  investment, 
as  collected  should  be  treated  as  income.    When  a  note 
is  bequeathed,  its  value  is  its  face  value  plus  interest  ac- 
crued and  unpaid  at  decedent's  death.    This  value  is  estate 
corpus.    Therefore,  when  the  first  interest  payment  is  made 
and  collected,  such  payment  should  be  apportioned  so  that 
estate  income  will  receive  the  earnings  since  the  testator's 
death  and  the  taking  effect  of  the  bequest.    The  other  part 
of  the  earning  should  be  credited  to  corpus. 
Distinctions  Relating  to   Principal   (Corpus).— Similarly, 
illustrative  corpus  distinctions  are  indicated  below: 

1.  Delinquent  taxes  where  the  trustee  is  authorized  to  pur- 
chase property  for  the  estate.  The  trustee  either  must  see 
that  no  delinquent  taxes  exist,  or  must  retain  the  necessary 
amount  to  cover  them  out  of  the  purchase  price.  When 
taxes  are  delinquent,  it  is  assumed  the  purchase  price  will 
be  lessened  by  their  amount. 

2.  All  taxes  which  are  a  lien  on  the  estate  as  at  the  death  of 
the  devisor.  Such  payments  will  be  made  out  of  the  per- 
sonalty. This  is  sort  of  an  exception  to  the  general  rule 
that  one  who  enjoys  the  current  income  of  an  estate  should 
pay  the  current  taxes. 

3.  Where  the  life  tenant  dies  during  any  current  taxable  year, 
the  remainderman  should  assume  an  amount  proportionate 
to  the  time  the  life  tenant  has  not  enjoyed  the  estate  income. 
This  is  true  whether  taxes  are  payable  before  or  after  death 
of  the  life  tenant. 

4.  Special  improvement  taxes  where  the  question  has  been  ad- 
judicated by  proper  Court  proceedings  or  where  the  Court 
orders  same  to  be  paid  wholly  or  in  part  out  of  principal. 
Otherwise,  payment  shall  be  made  from  income.  It  may  be 
that  the  will  contains  a  provision  covering  the  point. 

5.  Rents  due  and  unpaid  owed  to  the  deceased  at  the  time 
of  death  are  part  of  the  principal  estate. 

6.  Natural  wear  and  tear  of  a  trust  estate.  Natural  deprecia- 
tion affects  the  principal  and  finally  falls  upon  the  remain- 


494 


ADVANCED  ACCOUNTING 


^f 


!«»« 


I 


derman.  Natural  depreciation  is  unavoidable,  and  neither 
the  trustee  nor  the  life  tenant  can  be  held  therefor.  Such 
decrease  will  not  appear  in  the  trustee's  accounts  until  the 
sale  of  the  particular  asset  or  assets  affected. 

7.  Collections  by  a  trustee  on  account  or  in  full  of  the  princi- 
pal of  notes  or  bonds  held  by  the  trustee  at  par,  should  be 
credited  to  corpus,  being  merely  a  change  of  assets  from  one 
form  to  another.  If  any  of  the  collected  proceeds  represent 
accrued  interest,  the  amount  representing  accrued  interest 

should  be  credited  to  income. 

8.  Attorneys'  fees  and  costs  for  removal  of  trustees  and  for 
the  appointment  of  successors  are  cliargeable  against  prin- 
cipal, as  being  incurred  in  preserving  the  integrity  of  the 
trust  as  a  whole.  The  same  would  be  true  of  attorneys' 
fees  and  costs  concerned  with  protecting  the  estate  assets. 
Again,  the  same  would  be  true  where  attorneys'  fees  and 
costs  are  incurred  in  connection  with  having  the  terms  of 
a  will  or  trust  instrument  interpreted,  where  such  terms  are 
uncertain. 

9.  Commissions  paid  an  agent  to  purchase  an  investment  of 
realty  or  personalty  out  of  corpus  funds  are  regarded  as 
adding  to  the  cost  of  the  property  purchased  and  are  charge- 
able against  the  principal  of  the  estate.  The  same  is  true 
when  commissions  are  paid  to  an  agent  who  sells  realty 
or  personalty  held  as  part  of  the  corpus  of  the  estate. 
Other  purchase  and  sales  expenses  which  do  not  come  under 
the  head  of  mere  administration  costs  may  be  considered 
as  chargeable  against  corpus. 

10.  Where  a  trustee  is  empowered  to  encumber  proi)erty  by 
a  mortgage,  the  proceeds  of  the  mortgage  note  principal 
should  be  considered  as  estate  principal.  Interest  payments 
on  such  mortgage  are  chargeable  against  income.  Pay- 
ments to  reduce  the  principal  of  the  mortgage  are  charge- 
able against  corpus. 

11.  Corporate  dividends  declared  out  of  undivided  profits  or 
surplus  earned  before  the  existence  of  the  trust,  and  divi- 
dends declared  out  of  profits  by  appreciation  of  property 
owned  by  the  corporation  at  the  time  of  creating  the  trust 


FIDUCIARY  STATEMENTS:   DECEDENTS'   ESTATES      495 

belong  to  the  remainderman  as  corpus   (dividends  out  of 
property  appreciation  can  only  come  about  by  sale). 

12.  When  corporate  stock  is  sold,  and  where  the  corporate 
capital,  undivided  profits,  and  surplus  at  the  time  of  sale 
practically  aggregate  the  amount  at  the  beginning  of  the 
trust,  all  the  sales  proceeds  should  be  considered  as  corpus. 

13.  At  times,  as  in  California,  corporate  directors  may  assess 
corporate  shares  after  they  are  full  paid,  to  help  meet 
corporate  debts.  Such  assessments  are  chargeable  against 
estate  corpus. 


CHAPTER  XV 
FIDUCIARY  STATEMENTS  (CONTINUED) 

Introduction. — In  the  last  chapter  certain  principles  were 
discussed  related  to  the  accounting  procedures  and  statements 
made  use  of  in  administering  the  estates  of  decedents.  That 
topic,  however,  revolved  around  the  death  of  an  individual,  this 
being  necessary  before  a  decedent's  estate  could  come  into  exist- 
ence. 

The  inability  of  an  individual,  or  an  organization  (a  partner- 
ship or  corporation)  to  meet  financial  obligations  when  due  might 
constitute  excellent  grounds  for  the  intervention  of  a  disin- 
terested party  who  will  take  over  the  custodianship  of  properties 
and  dispose  of  them  in  accord  with  certain  legal  rules  or  instruc- 
tions received  from  a  Court. 

When  there  is  insufficient  property  on  hand,  at  a  fair  valua- 
tion, with  which,  or  out  of  which,  a  person  can  pay  his  debts, 
such  person  is  said  to  be  insolvent.  Such  a  condition  is  interest- 
ing to  an  accountant  because  thereunder  certain  forms  of  state- 
ments or  exhibits  either  are  required  or  useful;  these  statements 
or  exhibits  never  are  used  in  any  other  connection.  Briefly, 
these  statements  are: 

1.  Receivership  and  bankruptcy  statements. 

2.  Statement  of  affairs  with  accompanying  deficiency  account. 

3.  Statement  of  realization  and  liquidation. 

A  discussion  of  the  first  two  forms  the  content  of  the  present 
chapter,  whereas,  a  discussion  of  the  last  will  be  considered  in 
the  next  chapter. 

Insolvency  Versus  Bankruptcy. — Wlien  an  individual  or  an 
organization  is  said  to  be  insolvent,  two  possibilities  as  to  mean- 
ing present  themselves: 

1.  Is  the  individual  or  organization  only  financially  embar- 
rassed?   This  means  merely  that,  in  the  usual  course  of 

496 


FIDUCIARY  STATEMENTS:  INSOLVENTS'  ESTATES      497 

business,  the  assets  have  become  tied  up  in  some  way  or 
another  to  the  end  that  they  are  not  available  with  which 
to  meet  current  maturing  obligations,  as  payrolls,  notes, 
taxes,  etc.  In  this  instance,  the  value  of  the  assets  is  not 
less  than  the  gross  amount  of  the  liabilities.  Legally,  the 
business  or  individual  is  insolvent;  commercially,  insolvency 
is  not  present,  because  there  exists  only  a  temporary  in- 
ability to  pay  debts.  It  might  be  possible,  of  course,  that 
these  unpaid  obligations  will  be  reduced  to  judgments,  the 
latter  to  be  satisfied  by  a  levy  upon,  and  a  taking  of,  avail- 
able property.  In  this  event,  the  operation  of,  say,  the 
business,  will  cease.  But  it  is  just  as  possible  that  something 
can  be  done  to  avoid  reducing  these  obligations  to  judg- 
ments. By  hustling  around,  money  may  be  borrowed  with 
which  to  meet  payrolls,  or  the  banks  and  other  creditors 
may  renew  the  notes  outstanding.  By  such  legitimate 
manipulation,  the  period  of  stringency  may  be  passed  safely 
to  the  end  that  within  a  short  time  funds  will  be  collected 
from  regular  sources  with  which  to  meet  the  debts. 

2.  Is  the  individual  or  organization  in  a  condition  where  the 
value  of  the  assets  on  hand  is  less  than  the  gross  amount 
of  the  liabilities?  This  condition  would  seem  to  be  that  of 
true  insolvency ;  it  is  in  accord  with  the  type  of  insolvency 
contemplated  under  the  National  Bankruptcy  Act.  To  be 
actually  insolvent,  the  assets  of  an  individual  or  an  organi- 
zation, other  than  cash  funds,  must  be  considered.  Many 
individuals  and  organizations,  if  called  upon  to  pay  their 
debts  at  a  specified  moment  of  time  could  not  do  so.  If 
all  the  depositors  of  a  bank  should  demand,  at  a  specified 
moment,  the  total  sums  they  have  therein  deposited,  the 
bank  would  not  be  able  to  pay  them;  still,  one  could  not 
say  that,  because  of  this  reason  alone,  the  bank  was  in- 
solvent. Insolvency  is  a  situation  applied  to  a  debtor 
who,  being  pressed  for  payment,  presents,  say,  a  Balance 
Sheet  which,  when  given  the  fairest  possible  estimate, 
would  show  assets,  when  turned  into  cash,  insufficient  to  pay 
the  liabilities. 

Insolvency,  therefore,  is  better  defined  as  that  condition  of  an 


498 


ADVANCED  ACCOUNTING 


il     \ 


!        * 


I 


individual,  a  partnership,  or  a  corporation  in  which  the  assets 
taken  at  the  best  and  fairest  estimate  possible  will  not  pay  the 
liabilities.  The  National  Bankruptcy  Act  defines  the  term  along 
the  following  lines:  "A  person  shall  be  deemed  insolvent  .  . 
whenever  the  aggregate  of  his  property,  exclusive  of  any  prop- 
erty which  he  may  have  conveyed,  transferred,  concealed,  or 
removed,  or  permitted  to  be  concealed  or  removed,  with  intent 
to  defraud,  hinder  or  delay  his  creditors,  shall  not,  at  a  fair 
valuation  be  sufficient  to  pay  his  debts."  This  definition  empha- 
sizes the  economic  viewpoint — actual  insolvency. 

Insolvency  and  bankruptcy  are  not  synonymous  terms.  An 
insolvent  is  not  a  bankrupt;  he  becomes  such  only  upon  adjudi- 
cation by  a  Court  of  proper  jurisdiction  growing  out  of  an  action 
brought  before  such  Court  either  by  himself  or  by  his  creditors 
to  have  him  declared  a  bankrupt. 

Equity  Receiverships.— These  are  possible  because  the  relief 
granted  by  a  Court  of  ordinary  jurisdiction  is  inadequate.  In 
general,  an  equity  receivership  is  not  securable  as  a  matter  of 
course,  inasmuch  as  it  is  considered  as  interferring  in  the  exer- 
cise of  one's  right  of  private  property.  Hence,  its  creation  will 
be  granted  only  after  strict  examination  with  due  regard  to  the 
attitude  of  the  petitioner  as  reflected  in  his  answer.  Jurisdiction 
over  an  equity  receivership  is  vested  in: 

1.  Courts  of  equity. 

2.  Federal  courts. 

The  varying  general  possibilities  under  which  an  equity  re- 
ceivership may  be  created,  are  about  as  follows: 

1.  Solvent  concerns  (partnerships  and  corporations). 

a.  Voluntary  dissolution. 

b.  Involuntary  dissolution. 

2.  Insolvent  concerns   (partnerships  and  corporations). 

a.  Voluntary  dissolution. 

b.  Involuntary  dissolution. 

3.  Disputes  between  creditors  and  debtors. 

4.  Disputes  between  vendors  and  vendees. 

5.  Disputes  between  covenantors  and  covenantees. 

6.  Misuse  or  waste  of  assets  by  partners  or  corporate  officers. 


4M^ 

f 


FIDUCIARY  STATEMENTS:  INSOLVENTS'  ESTATES      499 

7.  Disputes  arising  under  probate  or  administration 

8.  Etc.  ' 

In  New  York,  and  in  certain  other  states  the  statutes  cover  the 
creation  of  receiverships.  But  even  hereunder  the  creation  lies 
within  the  discretion  of  the  Court.  In  New  York,  a  Court  of 
Equity  is  the  Court  of  competent  jurisdiction  for  receivership 
creation.  Further,  under  the  New  York  statutes,  the  varying 
other  possibilities  under  which  a  receivership  may  be  created  are 
about  as  follows: 

1.  When  a  mortgage  is  foreclosed  under  a  condition  where  the 
property  value  involved  is  not  sufficient  to  meet  the  mort- 
gage obligation. 

2.  Incumbrance  of  property  income.  If  income,  rent,  and 
profits  are  not  mortgaged,  and  a  concern  is  insolvent,  a 
receivership  will  be  created  without  question. 

3.  Certain  dissolution  or  reorganization  proceedings. 
Federal  statutes,  also,  cover  the  matter  of  receiverships,  and 

these  receiverships  should  be  differentiated  carefully  from  those 
covered  by  local  statutes.  Federal  receivership  proceedings  are 
under  the  jurisdiction  of  the  U.  S.  District  Court  of  the  district 
within  which  is  located  the  main  office  of  the  concern  in  ques- 
tion. And  where  property  is  found  in  part  within  other  districts, 
the  administration  thereof  falls  to  the  lot  of  the  local  district 
Court  subject  to  the  control  of  the  Court  located  in  the  district 
containing  the  concern's  main  office.  These  subsidiary  proceed- 
ings are  called  ancillary  proceedings.  Individuals,  partnerships, 
and  corporations,  if  insolvent  or  bankrupt,  may  come  into  the 
federal  Courts.  Federal  receiverships  are  known  as  chancery 
receiverships. 

Procedure  in  Event  of  Financial  Embarrassment.— When 
an  individual  or  organization  shows  evidence  of  an  incapacity 
to  manage  affairs  satisfactorily,  it  is  logical  that  some  disinter- 
ested person  from  the  outside  should  be  secured  to  act  in  a 
fiduciary  role  for  protecting  the  rights  of  all  parties  interested. 
This  person  may  be  appointed  in  either  one  of  two  ways: 

1.  By  a  Court  of  competent  jurisdiction,  federal  or  state. 

2.  By  the  debtor  with  the  consent  of  his  creditors,  without 
the  intervention  of  the  Court. 

If  the  individual  or  organization  is  solvent,  yet  unable  to  meet 


500 


ADVANCED  ACCOUNTING 


i 


■■I  ! 


its  current  obligations,  and  wishes  to  avoid  bankruptcy  proceed- 
ings, two  possible  courses  of  procedure  are  open  which  agree 
with  what  has  been  stated  above: 

1.  a.  Apply  to  a  Court  of  Equity  for  the  appointment  of  a 

receiver  in  equity.  Such  a  procedure  is  an  involuntary 
one  on  the  part  of  the  principal  in  that  the  creditors 
will  make  application  for  the  appointment, 
b.  Apply  to  a  Court  of  Equity  for  the  appointment  of  a 
person  who  will  take  charge  of  the  business  and  realize 
all  he  can  out  of  it  for  the  benefit  of  the  creditors.  The 
person  appointed  under  these  circumstances  is  an  as- 
signee, in  that  the  principal  makes  application  therefor 
and  assigns  for  the  benefit  of  the  creditors.  However, 
it  must  be  remembered  that  under  a  manipulation  of 
this  kind,  the  creditors  may  institute  bankruptcy  pro- 
ceedings immediately,  and  thereby  defeat  the  purpose 
the  principal  had  in  mind.  Such  a  procedure  is  a  volun- 
tary one  on  the  part  of  the  principal  as  distinguished 
from  the  involuntary  one  mentioned  above. 

2.  If  the  principal  and  his  creditors  get  together  by  agreement 
without  the  intervention  of  a  Court,  and  agree  to  continue 
the  business  or  to  close  out  the  assets  and  pay  off  as  much 
of  the  liabilities  as  possible,  appointing  someone  as  a 
fiduciary  to  carry  out  their  wishes  to  this  extent,  the  person 
so  appointed  is  known  as  a  friendly  trustee. 

Assignments  in  Favor  of  Creditors. — In  every  state  in- 
solvency laws  exist  which  may  be  taken  advantage  of  by  an  in- 
solvent in  that  he  can  apply  to  the  Court  for  the  appointment 
of  an  assignee  to  liquidate  affairs  for  tlie  interest  of  all  creditors. 
At  the  present  time,  in  most  states,  and  under  federal  statutes 
as  well,  it  is  illegal  to  make  an  assignment  for  the  benefit  of 
only  certain  creditors.  An  assignment  may  cover  all,  or  only 
a  portion,  of  the  debtor's  assets. 

The  assignee  takes  over  these  assets  in  trust,  with  the  pur- 
pose in  mind  of  applying  either  the  actual  property  or  the  pro- 
ceeds secured  from  the  sale  of  such  property  to  the  payment  of 
the  debts  in  question  (some  or  all) ,  and  to  return  to  the  debtor 
any  excess  remaining  after  such  application.  When  an  assign- 
ment is  in  order,  the  assignee  secures  such  a  control  over  the 


FIDUCIARY  STATEMENTS:   INSOLVENTS'  ESTATES      501 

properties  assigned  that  both  the  assigning  party  and  the  unse- 
cured creditors  cannot  in  any  way  reach  it. 

The  assignee  works  under  Court  direction,  realizing  upon  the 
assets  placed  in  his  care,  and  paying  off  creditors  in  the  order 
of  preference  and  accounting  to  the  Court  relative  to  his  cus- 
todianship by  means  of  certain  schedules.  These  insolvency 
laws  might  operate  to  the  benefit  of  all  concerned,  but  seldom 
are  they  made  use  of  because  of  the  existence  of  the  National 
Bankruptcy  Act. 

Effect  of  National  Bankruptcy  Act  upon  Assignments.— 
Under  the  Constitution  of  the  U.  S.,  "Congress  shall  have  power 
to  establish  uniform  laws  on  the  subject  of  bankruptcy  through- 
out the  United  States."  Congress  has  exercised  this  right  by 
passing  several  different  laws,  the  one  in  force  at  present  being 
the  law  of  1898  plus  its  several  amendments.  The  several  states 
are  not  prohibited  from  passing  legislation  concerning  bank- 
ruptcy, but  any  state  law  on  this  subject  must  not  conflict  with 
the  federal  law.  Therefore,  if  advantage  is  taken  of  the  in- 
solvency laws  of  any  state,  the  insolvent  may  be  forced  into  bank- 
ruptcy under  the  federal  law.  Because  of  this  fact,  if  an  assign- 
ment is  made  under  a  state  law,  without  the  consent  of  the 
creditors,  the  latter,  because  of  the  superiority  of  jurisdiction  of 
the  federal  statutes,  may  invoke  the  aid  of  the  national  law, 
throw  the  insolvent  into  bankruptcy  and,  thereby,  defeat  the 
latter's  purpose. 

Upon  any  point  at  which  no  conflict  exists  between  Federal 
and  state  jurisdiction,  the  state  insolvency  laws  govern.  There- 
fore, the  state  laws  are  enforced  only  where  the  provisions  of 
the  federal  act  have  not  been  invoked.  Because  of  the  conflict 
in  jurisdiction,  the  state  law  is  practically  inactive,  except  where 
all  parties  agree  to  be  governed  by  the  state  statute. 

To  the  debtor,  the  advantage  of  the  federal  law  lies  in  the 
fact  that  thereunder,  if  he  has  been  only  unfortunate  and  not 
fraudulent,  he  may,  by  being  adjudicated  a  bankrupt: 

1.  Be  discharged  from  all  his  past  debts  and  thereby  be  given 
a  fresh  start  to  build  up  new  credit  with  the  satisfaction 
of  knowing  that  as  soon  as  he  secures  a  little  money  it  will 
not  be  taken  to  make  good  an  old  claim. 

2.  The  creditors  thereunder  have  the  advantage  of  sharing 


t 


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ADVANCED  ACCOUNTING 


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alike  (those  wlio  are  unsecured)  with  no  one  scH'uring  an 
undue  advantage  by  fraud  or  unfairness. 

On  the  other  hand,  the  usual  state  insolvency  law  is  merely 
a  compilation  of  rules  and  regulations  covering  the  distribution 
of  the  estate  of  an  insolvent  after  assigrmient. 

Bankruptcy;  Receiver  Versus  Trustee  in  Bankruptcy.— 
When  an  individual  or  an  organization  is  insolvent,  i  e., — when 
assets  are  less  than  debts,  the  debtor  may  seek  voluntary  bank- 
ruptcy proceedings,  or  the  creditors  may  seek  involuntary  bank- 
ruptcy proceedings.  If  voluntary,  the  debtor  files  a  petition  in 
a  district  Court  of  the  U.  S.,  setting  out  therein  the  number  and 
amount  of  his  debts  and  the  amount  of  his  property.  The 
creditors  are  then  notified,  and  copies  of  this  petition  are  given 
them.  From  this  point  on,  the  procedure  of  voluntary  and  invol- 
untary bankruptcy  is  practically  the  same.  In  urgent  cases,  the 
Court  will  appoint  some  one  to  take  charge  of  the  estate  until 
the  regular  trustee  in  bankruptcy  has  qualified.  This  person  is 
called  a  receiver  in  bankruptcy. 

This  receiver  is  charged  with  protecting  and  caring  for  the 
property  of  the  debtor  until  such  time  as  the  creditors  can  get 
together  and  appoint  a  trustee  or  trustees  in  bankruptcy.  The 
receiver  in  bankruptcy,  therefore,  is  seen  to  have  duties  differ- 
ent from  those  of  a  receiver  in  equity.  He  merely  cares  for  the 
property,  and  his  activities  relating  thereto  depend  entirely  upon 
the  instructions  he  receives  from  the  Court.  He  does  not  operate 
the  business,  nor  does  he  realize  upon  the  assets  and  liquidate 
the  liabilities;  only  when  assets  are  of  a  perishable  nature,  and 
with  the  consent  of  the  Court,  will  he  realize  upon  the  assets. 

Any  insolvent  person  may  file  a  bankruptcy  petition  on  his 
own  account  by  asking  the  Court  to  adjudge  him  a  bankrupt. 
The  amount  owed  by  such  a  person  is  immaterial.  Voluntary 
proceedings,  as  a  rule,  are  infrequent,  except  when  one  is  hard 
pressed  by  creditors,  because  the  expense  involved  is  rather 
heavy. 

Involuntary  bankruptcy  may  be  brought  about  by  a  creditor 
if  the  debts  of  a  debtor  are  not  less  than  $1,000.00,  and  an  act 
of  bankruptcy  has  been  committed.  The  Bankruptcy  A(?t  points 
out  that  the  following  are  acts  of  bankruptcy: 

1.  To  convey,  transfer,  conceal,  or  remove,  or  to  permit  to  be 


FIDUCIARY  STATEMENTS:  INSOLVENTS'  ESTATES      503 

concealed  or  removed,  any  part  of  his  property  with  intent 
to  hinder,  delay,  or  defraud  his  creditors  or  any  of  them. 

2.  To  transfer  while  insolvent  any  portion  of  his  property 
to  one  or  more  creditors  with  intent  to  prefer  such  creditors 
over  his  other  creditors. 

3.  To  suffer  or  permit,  while  insolvent,  any  creditor  to  obtain 
a  preference  through  legal  proceedings,  and  not  have  va- 
cated or  discharged  such  preference  at  least  five  days  be- 
fore a  sale  or  final  disposition  of  any  property  affected 
by  such  preference. 

4.  To  make  a  general  assignment  for  the  benefit  of  his 
creditors,  or  being  insolvent  to  apply  for  a  receiver  or  a 
trustee  for  his  property,  or  to  have  had  a  receiver  or  a 
trustee  put  in  charge  of  his  property  because  of  insolvency. 

6.  To  have  admitted  in  writing  his  inability  to  pay  his  debts 
and  his  willingness  to  be  adjudged  a  bankrupt  on  that 
ground. 

One  who  has  committed  any  such  act  of  bankruptcy  is  liable 
to  have  filed  against  him  a  petition  asking  he  be  adjudged  bank- 
rupt at  any  time  within  four  months  thereafter. 

Bankruptcy  proceedings  may  be  brought  by  any  one  or  more 
creditors  when  the  alleged  bankrupt  owes  not  less  than  $500.00, 
if  the  total  number  of  creditors  is  less  than  twelve.  If  there  are 
twelve  or  more,  three  or  more  must  join  in  bringing  the  proceed- 
ings, and  their  claims  must  aggregate  more  than  $500.00. 

Bankruptcy  proceedings  may  be  brought  against  any  natural 
person,  other  than  a  wage-earner  or  a  person  engaged  chiefly 
in  farming.  They  may  be  brought  against  an  unincorporated 
company  and  against  any  corporation  whose  debts  amount  to 
$1,000.00  or  more.  However,  a  municipal  corporation,  a  rail- 
road, an  insurance  company,  or  a  bank  cannot  have  bankruptcy 
proceedings  instituted  against  them  for  reasons  of  public  policy. 
If  any  one  of  these  corporations  becomes  insolvent,  the  creditors 
may  apply  to  a  Court  of  Equity  to  have  a  receiver  appointed 
to  take  charge  of  the  assets  and  the  business  on  behalf  of  the 
creditors. 

Trustees  in  Bankruptcy.— As  soon  as  the  creditors  have 
appointed  a  trustee,  or  trustees  (there  may  be  three  of  them),  the 
latter  must  proceed  immediately  to  realize  upon  the  assets  and 


I 


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II 

Hi 


504 


ADVANCED  ACCOVNTING 


1 


»' 


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nil 


IX 


to  liquidate  the  liabilities.  When  this  activity  has  been  com- 
pleted, or  at  intervals  during  the  realization  and  liquidation 
process,  the  trustees  may  be  required  to  render  an  accounting  to 
the  Court.  This  will  be  discussed  at  a  later  time  in  the  next 
chapter. 

H.  C.  Bentley,  C.  P.  A.,  in  his  "Science  of  Accounts."  a  book 
now  out  of  print,  has  discussed  so  well  the  appointment  and  du- 
ties of  a  trustee  in  bankruptcy,  pages  275-277,  that  the  writer 
takes  the  liberty  of  introducing  a  quotation  therefrom  at  this 
point: 

When  an  individual,  partnership  or  business  corporation  has  been 
adjudged  a  bankrupt,  the  creditors  at  their  first  meeting  after  the 
adjudication  (date  of  entry  of  the  decree)  should  appoint  one  or  more 
trustees,  as  may  be  required.  In  case  they  do  not  exercise  this  privi- 
lege, the  court  will  appoint.  The  first  meeting  referred  to  above  must 
be  held  not  less  than  ten  nor  more  than  thirty  days  after  the  adjudi- 
cation, at  the  county  seat  of  the  county  in  which  the  bankrupt  had  his 
principal  place  of  business. 

The  trustee  in  bankruptcy  must  account  for  all  moneys  belonging 
to  the  bankrupt  concern  which  may  be  received  by  him;  collect  and 
reduce  to  money  the  property  of  the  bankrupt;  deposit  all  moneys 
received  by  him  as  such  trustee  in  a  bank  designated  by  the  court; 
disburse  the  funds  only  by  check;  lay  before  the  final  meeting  of  the 
creditors  detailed  statements  of  the  administration  of  tl^e  estate;  make 
final  reports  and  file  final  accounts  with  the  referee  fifteen  days  before 
the  day  fixed  for  the  final  meeting  of  the  creditors,  and  pay  dividends 
within  ten  days  after  they  are  declared  by  the  referee.  He  must  also 
report  to  the  court,  in  writing,  the  condition  of  the  estate  and  the  amount 
of  money  on  hand,  together  with  such  other  details  as  may  !)e  required 
by  the  court,  within  the  first  two  months  after  his  appointment  and 
every  two  months  thereafter,  unless  otherwise  ordered  by  the  court. 
(The  court  refers  to  the  bankruptcy  court  in  which  proceedings  are 
pending,  and  may  include  the  referee, — the  direct  representative  of 
the  court  of  their  appointment  for  handling  the  many  details  that 
otherwise  would  have  to  be  handled  by  a  judge.) 

It  is  customary  for  the  trustee  to  compile,  or  have  compiled,  a  state- 
ment of  affairs  and  a  deficiency  statement, as  soon  as  pos- 
sible after  his  appointment.  From  these  two  statements  the  court, 
the  trustee,  and  any  other  persons  at  interest,  may  gain  a  fair  idea  of 
the  probable  results  from  liquidation.  It  is  not  compulsory  on  the 
trustee  to  have  such  statements  compiled,  but  it  is  usually  done  as  a 
matter  of  good  practice. 


.1 

i: 


FIDUCIARY  STATEMENTS:  INSOLVENTS'  ESTATES      505 

The  only  statement  actually  required  by  the  court  must  be  furnished 
by  the  bankrupt  himself  within  ten  days  after  the  adjudication  if  an 
involuntary  bankrupt,  and  consists  of  a  schedule  of  his  property  showing 
the  amount  and  kind  of  property,  the  location  thereof,  and  its  money 
value  in  detail;  a  list  of  creditors  with  their  addresses,  the  amount  due 
each  of  them,  the  consideration  thereof,  the  security  held  by  them,  if 
any;  and  a  claim  for  such  exemptions  as  the  bankrupt  may  be  entitled 
to.     This  report  must  be  rendered  in  triplicate. 

In  the  above  quoted  paragraphs,  mention  is  made  of  two  sepa- 
rate statements: 

1.  The  statement  required  by  the  Court  to  be  filed  by  the 
bankrupt  himself. 

2.  The  statement  of  affairs  and  accompanying  deficiency  ac- 
count, customary  but  not  required  by  the  Court. 

A  consideration  of  these  two  statements  brings  one  to  the  dis- 
cussion comprising  the  latter  portion  of  this  chapter. 

Content  of  Bankruptcy  Statements.— In  bankruptcy  pro- 
ceedings, the  only  statement  actually  required  by  the  Court 
must  be  furnished  by  the  bankrupt  himself: 

1.  Within  ten  days  after  an  involuntary  bankrupt  has  been 
adjudicated  a  bankrupt,  and 

2.  If  a  voluntary  bankrupt,  with  the  petition. 

This  statement  takes  a  prescribed  form  which  has  been  set 
forth  by  the  bankruptcy  law.  The  schedules  required  are  for 
the  purpose  of  setting  forth  the  different  classes  of  debts  and 
creditors,  and  whether  they  are  preferred,  fully-secured,  or 
partly-secured,  the  amount  and  kind  of  each  property  of  the 
bankrupt  and  its  location  and  money  value  in  detail,  and  a 
claim  for  the  exemptions  to  which  the  bankrupt  may  be  entitled. 
Three  copies  of  this  report  must  be  submitted.  These  state- 
ments in  no  way  are  presented  in  such  an  accounting  form  that 
they  will  show  clearly  the  aggregate  of  all  debts  and  the  result 
upon  the  unsecured  creditors.  It  seems  that  the  Courts  have 
departed  as  little  as  possible  in  all  matters  of  accounts  from 
the  simplest  and  most  primitive;  advances  in  accoimting  pro- 
cedure have  not  been  taken  advantage  of  by  them. 

Content  of  Schedule  ^1.— The  bankruptcy  schedules  are  divided 
into  two  parts: 

1.  Schedule  A.    This  schedule  is  subdivided  into  five  sections, 


506 


ADVANCED  ACCOUNTING 


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I 


in  which  are  shown  the  bankrupt's  debts,  and  the  order 
in  which  they  rank;  each  subdivision  must  be  signed  by  the 
bankrupt. 

2.  Schedule  B.  This  schedule  is  subdivided  into  six  sections, 
in  which  are  shown  the  bankrupt's  assets;  each  subdivision 
must  be  signed  by  the  bankrupt. 

The  contents  of  schedule  A,  covering  debts,  are  indicated 
below : 

Subdivision  i.— Herein  there  must  be  set  out  in  detail  the 
creditors  to  be  paid  in  full— the  preferred  creditors,  their  names 
and  residence  (if  residence  is  not  known,  such  fact  must  be 
stated),  where  and  when  the  debt  was  contracted,  the  nature  of 
such  debt  and  its  consideration,  its  amount,  and  proper  reference 
to  the  books  of  account  (as  Ledger) .  The  order  of  preference 
for  such  debts  is  as  follows: 

a.  Taxes  and  debts  due  and  owing  to  the  U.  S. 

b.  Taxes  due  and  owing  to  the  State,  or  to  any  county, 
district,  or  municipality  thereof. 

c.  Wages  due  workmen,  clerks,  or  servants,  in  an  amount 
not  to  exceed  $300.00  each,  earned  within  three  months 
before  filing  the  petition. 

d.  Other  debts  preferred. 

Subdivision  ^.— This  subdivision  shows  creditors  holding  secur- 
ities, particulars  concerning  securities  hold,  their  dates,  and  when 
given;  these  facts  are  to  be  set  out  under  the  names  of  the 
creditors  involved.  Also,  there  must  be  shown  the  particulars 
concerning  each  debt,  whether  same  was  contracted  as  partner 
or  joint  contractor  with  any  other  person,  and  if  so,  with  whom, 
residences  (if  not  known,  fact  to  be  stated),  value  of  securities,' 
and  amount  of  the  debts. 

Subdivision  5.— This  subdivision  shows  the  unsecured  credi- 
tors, their  names  and  residences  (if  latter  unknown,  fact  to  be 
stated),  when  and  where  the  obligations  were  contracted,  nature 
and  consideration  of  the  debt,  and  whether  any  judgment,  bond, 
bill  of  exchange,  or  promissory  note,  etc.,  and  amount.  When 
name  and  residence,  or  either,  of  any  drawer,  maker,  indorser, 
or  holder  of  any  bill  or  note,  etc.,  are  unknown,  such  fact  must 
be  shown,  and  also  the  name  and  residence  of  the  last  holder 
known  to  the  debtor.    The  debt  due  each  creditor  must  be  stated 


FIDUCIARY  STATEMENTS:   INSOLVENTS'  ESTATES      507 

in  full,  and  any  claim  by  way  of  set-off  stated  in  the  property 
schedule. 

Subdivision  4.— This  shows  the  liabilities  on  notes  or  bills 
discounted  which  ought  to  be  paid  by  the  drawers,  makers, 
acceptors,  or  indorsers,  the  names  of  holders  so  far  as  is  known 
and  their  residence  (if  unknown,  fact  must  be  stated),  place 
where  contracted,  nature  of  liability,  whether  same  was  con- 
tracted as  partner  or  joint  contractor,  or  with  any  other  person, 
and  if  so,  with  whom,  and  amount.  The  dates  of  the  notes  or 
bills,  and  when  due,  with  names,  residence,  and  business  or 
occupation  of  the  drawers,  makers,  or  acceptors  thereof  are  to 
be  set  out  under  the  names  of  the  holders.  If  names  of  holders 
are  not  known,  the  name  of  the  last  holder  known  to  debtor 
should  be  stated,  and  his  business  and  place  of  residence  and  the 
same  particulars  as  to  notes  or  bills  on  which  the  debtor  is 
liable  as  indorser. 

Subdivision  5.— This  sets  forth  the  accommodation  paper,  the 
names  of  holders,  residences  (if  not  known,  fact  to  be  shown), 
names  and  residences  of  persons  accommodated,  place  where 
contracted,  nature  of  liability  and  amount. 

Content  of  Schedule  B.— The  content  of  schedule  B,  covering 
the  assets,  is  as  follows: 

Subdivision  1. — This  subdivision  sets  out  the  real  estate 
owned  or  held  by  the  debtor,  indicating  in  detail  the  location  and 
description  thereof,  the  encumbrances  thereon,  if  any,  the  dates 
thereof,  particulars  relating  thereto,  and  the  estimated  value. 

Subdivision  2. — This  sets  out  the  personal  property  of  the 
bankrupt,  the  value  of  each  class  being  shown  in  order  as 
follows: 

a.  Cash  on  hand. 

b.  Bills  of  exchange,  promissory  notes,  or  securities  of  any 
description  (each  to  be  set  out  separately). 

c.  Stock  in  trade. 

d.  Household  goods  and  furniture,  household  stores,  wear- 
ing apparel  and  ornaments  of  the  person. 

e.  Books,  prints  and  pictures. 

f.  Horses,  cows,  sheep  and  other  animals  (number  of  each), 
g.  Carriages  and  other  vehicles. 


508 


ADVANCED  ACCOUNTING 


m 


h.  Farming  stock  and  implements  of  husbandry. 
i.  Shipping  and  shares  in  vessels. 

k.  Machinery,  fixtures,  apparatus  and  tools  used  in  busi- 
ness, with  the  place  where  each  is  situated. 
1.  Patents,  copyrights  and  trademarks, 
m.  Goods  or  personal  property   of  any  other  description, 
with  the  place  where  each  is  situated. 

Suhdivision  5.— This  sets  out  the  choses  in  action,  as  indicated 
I>elow : 

a.  Debts  due  petitioner  on  open  account. 

b.  Stocks  in  incorporated  companies,  interest  in  joint 
stock  companies,  and  negotiable  bonds. 

c.  Policies  of  insurance. 

d.  Unliquidated  claims  of  every  nature,  with  their  esti- 
mated value. 

e.  Deposits  of  money  in  banking  institutions  and  elsewhere. 
Subdivision  4.— This  states  the  property  in  reversion,  remain- 
der or  expectancy,  including  property  held  in  trust  for  the  debtor 
or  subject  to  any  power  or  right  to  dispose  of  or  to  charge. 
Other  items  to  be  included  are: 

a.  All  property  heretofore  conveyed  for  benefit  of  creditors, 
with  amount  realized  thereon. 

b.  All  sums  paid  to  counsel,  and  to  whom,  for  services 
rendered  or  to  be  rendered  in  the  bankruptcy  proceed- 
ings. 

Subdivision  5.— This  is  a  statement  of  all  property  claimed  to 
be  exempt: 

a.  Military  uniforms,  arms,  and  equipment. 

b.  Property  claimed  to  be  exempted  by  state  laws,  its  valu- 
ation, whether  real  or  personal,  its  description  and  pres- 
ent use.  The  state  statute  referred  to  should  be  indi- 
cated, as  well  as  the  total  value  thereunder  exempt. 

Subdivision  <?.— This  is  a  list  of  books,  papers,  deeds  and  writ- 
mgs  relating  to  bankrupt's  business  and  estate.  If  these  are  in 
the  hands  of  some  one  other  than  the  petitioner,  their  names 
must  be  given,  and  the  reasons  why  they  are  so  held. 

Summary  of  Schedules  A  and  B.— This  summary  is  made  after 
the  schedules  have  been  prepared.    It  would  appear  aa  follows: 


FIDUCIARY  STATEMENTS:  INSOLVENTS'  ESTATES      509 

Summary  of  Debts  and  Assets 
Schedule  A 


Subdivision  1. 

a. 

Taxes  and  debts  due  United  States,                          $  ^ 

b. 

Taxes  due  states,  counties,  districts,  and  munici- 
palities,                                                                          1  ^ 

c. 

Wages,                                                                           g  ^ 

d. 

Other  debts  preferred  by  law,                                      $  ^ 

Subdivision  2. 

Secured  claims,                                                              $  ^ 

Subdivision  3. 

Unsecured  claims,                                                         |  ^ 

Subdivision  4. 

Notes  and  bills  which  ought  to  be  paid  by  other 
parties  thereto,                                                                |  ^ 

Subdivision  5. 

Accommodation  paper,                                                 $  ^ 
Schedule  A,  Total,                                                  $  ^ 

Schedule  B 

Subdivision  1. 

Real  estate,                                                                  |  ^ 

Subdivision  2. 

a. 

Ca^sh  on  hand,                                                                  f  ^ 

b. 

Bills,  promissory  notes,  and  securities,                       $  ^ 

c. 

Stock  in  trade,                                                                   f  ^ 

d. 

Household  goods,  etc.,                                                    $  ^ 

e. 

Books,  prints,  and  pictures,                                         f  ^ 

f. 

Horses,  cows,  and  other  animals,                                  $  ^ 

g. 

Carriages  and  other  vehicles,                                        $  ^ 

h. 

Farming  stock  and  other  implements,                         $  ^ 

• 

1. 

Shipping  and  shares  in  vessels,                                    $  ^ 

k. 

Machinery,  tools,  etc.,                                                     $  ^ 

1. 

Patents,  copyrights,  and  trademarks,                         $  ^ 

m. 

Other  personal  property,                                               $  ^ 

Subdivision  3. 

a. 

Debts  due  on  open  accounts,                                        %  ^ 

b. 

Stocks,  negotiable  bonds,  etc.,                                      $  ^ 

• 

c. 

Policies  of  insurance,                                                      $  ^ 

d. 

Unliquidated  claims,                                                       $  ^ 

e. 

Deposits  of  money  in  bank  and  elsewhere,                 $  ^ 

Subdivision  4. 

Property  in  reversion,  remainder,  trust,  etc.,             $  ^ 

Subdivision  5. 

Property  claimed  to  be  exempted,                               $  jf 

Subdivision  6. 

Books,  deeds,  and  papers,                                              $  ^ 
Schedule  B,  Total,                                             $  ^ 

Illustrative  Problem:   Receivership. — A  malting  company 
was  placed  in  the  hands  of  a  receiver  in  bankruptcy. 


The  assets  inventoried  by  the  receiver  were: 
Accounts  receivable. 
Grain  and  products  in  malt  house, 

Total,  representing  nominal  capital. 


$218,477  15 
29,359.74 

1247,836.89 


An  order  of  the  court  was  entered  instructing  the  receiver  to  continue 
the  operation  of  the  business.     After  the  receiver  had  operated  the  business 


■\. 


I 


■  II    MIL 


It- 


II 


510 


ADVANCED  ACCOUNTING 


two  months,  a  settlement  was  effected,  and  the  receiver  was  discharged  by 
the  court,  the  bankrupt  company  resuming  business. 

The  receiver's  books  of  the  bankrupt  company's  accounts  showed  at  the 
date  of  his  discharge: 

Collections  on  account  of  the  accounts  receivable,  inventoried  above, 
$10,097.60;  also,  that  in  trade  the  receiver  had  made  gross  sales  to  the 
amount  of  $114,806.62;  his  grain  purchases  were  $110,786.61;  manufactur- 
ing expenses  $7,279.07;  selling  expenses  $7,956.97;  receiver's  charges 
$1,000.00;  discounts,  shortages  and  merchandise  returned  on  sales  accounts 
$1,370.85;  on  hand  in  grain  and  products  $51,005.62;  he  has  collected  in 
cash  on  receiver's  sales  $65,448.83;  he  owes  on  open  account  $5,237.52; 
borrowed  from  banks  $46,251.10. 

Prepare  trading  statement  showing  profit  or  loss  from  receiver's  operations, 
and  prepare  final  balance  sheet  from  the  face  of  the  receiver's  accounts  of 
the  bankrupt  company  at  the  close  of  his  receivership. 

Solution  to  Problem.~The  only  important  i>oint  to  keep  in  mind  in  the 
solving  of  this  problem  is  the  fact  that  the  so-called  receiver  is  acting  in 
two  capacities: 

1.  Liquidating  the  old  business. 

2.  Trading. 

Hence,  it  is  necessary  to  keep  the  two  sets  of  transactions  as  separate, 
one  from  the  other,  as  is  possible.  Outside  of  this  one  point,  this  problem 
seems  lacking  entirely  in  suflicient  information  to  be  considered  of  much 
worth.  And  because  of  this  lack  of  information,  the  only  separation  here 
possible  relates  to  the  accounts  receivable. 

The  first  step  would  seem  to  be  to  prepare  a  Trial  Balance  of  the  accounts 
so  that  therefrom  the  statements  called  for  may  be  prepared.  This  is  given 
below  with  information  as  to  how  certain  of  the  items  therein  were  deter- 
mined: 

Cash  ($10,097.60  plus  $65,448.83  plus 

$46,251.10  minus  ($7,279.07  plus 

$7,956.97  plus  $105,549.09  plus 

$1,000.00)  ), 
Accounts  receivable: 

Old  ($218,477.15  minus  $10,097.60), 
New  ($113,435.77  minus  $65,448.83), 
Inventory  (grain  at  beginning). 
Purchases, 

Manufacturing  expense, 
Selhng  expense, 
Receiver's  expense. 
Bank  loan, 
Accounts  payable, 
Sales, 

Sales  returns,  allowances,  etc., 
Estate  capital  account. 

Totals, 


I  12.40 

208,379.55 

47,986.94 

29,359.74 

110,786.61 

7,279.07 

7,956.97 

1,000.00 


1,370.85 


$  46,261.10 

5,237.52 

114,806.62 

247,836.89 


$412,761 .28  $412 , 761 . 28 


FIDUCIARY  STATEMENTS:  INSOLVENTS'  ESTATES     511 

The  second  step  would  be  to  prepare  the  trading  statement  as  required; 
this  is  shown  below; 


Gross  Sales, 

Less:   Returns,  Allowances,  etc., 

Net  Sales, 

Less: 
Cost  of  Sales: 


Trading  Statement 


$114,806.62 
1,370  85 


$113,435.77 


Inventory,  Beginning, 
Purchases, 

Inventory,  End, 

Manufacturing  Expense, 
Selling  Expense, 

Profit  from  Trading, 


$  29,359.74 
110,786.61 

$140,146.35 

51,005.62  $  89,140.73 

7,279.07 
7,956.97 


Profit  and  Loss  Statement 


Profit  from  Trading  (as  above), 

Less: 
Receiver's  Expenses, 

Net  Profit  from  Receiver's  Operations 


104,376.77 
$9,059  00 

$9,059.00 

1,000.00 
$8,059.00 


Balance  Sheet 
Assets 


Accounts  Receivable: 
Old, 

New, 

Grain  and  Products  on  Hand,, 
Cash, 

Total, 


Liabilities 


Bank  Loan, 
Accounts  Payable, 

Estate  Capital  Account,  Beginning  Balance, 
Net  Profit  from  Receiver's  Operations, 
Total 


$208,379.55 

47,986.94  $256,366.49 

51,005.62 
12  40 

$307,384  51 

$  46,251.10 

5,237.52  $  51,488.62 
$247,836.89 

8,059  00   255,895.89 

$307,384.51 


Statement  of  Affairs  with  Accompanying  Deficiency 
Account. — The  second  statement  made  mention  of  above,  as 
covered  by  the  title  of  this  present  section,  is  next  to  be  discussed 
and,  in  this  connection,  from  a  double  point  of  view: 

1.  Financial  embarrassment,  as  where  creditors  cannot  be  paid 
promptly  even  though  assets  exceed  liabilities. 


512 


ADVANCED  ACCOUNTING 


II 


2.  Insolvency  due  to  the  fact  that  the  liabilities  exceed  the 
assets. 

a.  An  individual  or  organization  may  be  able  to  pay  current 
obligations  in  the  immediate  present  and  perhaps  dur- 
ing the  near  future,  but  because  liabilities  exceed  assets, 
a  time  will  not  be  far  remote  in  which  the  obligations  can- 
not be  paid  due  to  exhaustion  of  assets. 

b.  An  individual  or  organization  going  through  bankruptcy. 
In  each  of  the  above  cases,  impending  or  actual  in- 
solvency is  seen.  And  under  each  of  these  circumstances 
it  is  necessary  to  secure  more  capital,  to  reorganize  in 
some  way  as  by  a  change  of  personnel,  or  to  dissolve  en- 
tirely. Regardless  of  the  remedy,  the  creditors  and  pro- 
prietors are  vitally  interested,  especially  as  to  the  rela- 
tion of  available  asset  values  against  liabilities. 

Both  classes  of  persons  interested  must  have  the  financial 
condition  of  the  activity  so  displayed  that  they  can  see  clearly 
the  probable  outcome  of  the  reorganization  or  the  probable  pro- 
ceeds resulting  from  realization.  And  in  this  connection,  the 
creditors'  claims  are  of  first  importance  as  to  the  order  in  which 
they  will  be  met  and  the .  percentages  thereof  to  be  paid.  If 
an  individual  or  an  organization  be  insolvent,  no  principal,  under 
the  law,  can  take  precedence  over  any  creditor  in  the  distribution 
of  the  assets.  Likewise,  where  bankruptcy  either  is  trying  to  be 
avoided, — as  by  the  appointment  of  a  friendly  trustee, — or  is 
actually  contemplated,  it  is  necessary  to  compare  the  original 
financial  position  with  the  possible  realizable  position. 

For  such  purpose,  the  usual  Balance  Sheet  is  entirely  inade- 
quate, the  reasons  therefor  being  about  as  under: 

1.  Since  the  possibility  exists  that  the  assets  are  not  to  be 
continued  in  use  by  the  activity,  at  least  wholly,  those 
not  to  be  thus  continued  must  be  sold  at  whatever  can  be 
procured  for  them.  A  Balance  Sheet  cannot  indicate  what 
will  be  the  amount  of  this  estimated  realization. 

2.  When  assets  are  sold  at  a  forced  sale,  they  will  pro<iuce 
much  less  than  the  booked  value,  i.  e.,  the  value  at  which 
a  going  concern  is  entitled  to  carry  them;  a  shrinkage  is 
bound  to  result.  A  Balance  Sheet  cannot  point  out  what 
the  amount  of  such  shrinkage  may  be. 


FIDUCIARY  STATEMENTS:  INSOLVENTS'   ESTATES      513 


3.  A  Balance  Sheet  does  not  show  whether  or  not  any  of  the 
assets  are  held  as  security  by  any  of  the  creditors;  it  does 
not  indicate  whether  any  particular  creditors  must  be  paid 
before  other  creditors;  and  it  does  not  present  the  amount 
of  the  net  free  assets  out  of  which  the  unsecured  creditors 
may  expect  payment. 
It  is  apparent,  therefore,  that  a  special   form  of  statement 
must  be  prepared  to  set  out  the  facts  necessary  in  accord  with 
the  above  requirements.    And  the  basic  statement  for  this  pur- 
pose, to  which  reference  has  been  made  already,  which  will  pre- 
sent the  proper  viewpoint  of  conditions,  and  be  a  proper  basis 
for  accounting,  is  the  Statement  of  Affairs,  supplemented  by 
a  schedule  showing  the  causes  of  insolvency  variously  called  a 
Deficiency  Account  or  Deficiency  Statement. 

Strictly  speaking,  a  Statement  of  Affairs  presents  the  assets 
and  liabilities  of  a  business  brought  to  a  balance  by: 

1.  Deficiency,  if  the  liabilities  exceed  the  assets. 

2.  Capital  or  surplus,  if  the  assets  exceed  the  liabilities. 

It  would  be  prepared,  in  whole  or  in  part,  from  information 
secured  from  sources  other  than  books  of  double  entry.  There- 
fore, such  a  statement  might  be  prepared  from  books  kept  by 
single  entry,  or  from  facts  that  have  no  reference  to  any  books 
of  account.  However,  as  commonly  used,  the  term  refers  to  a 
statement  of  the  type  mentioned  above  in  the  present  chapter 
relating  to  an  insolvent  estate. 

As  soon  as  possession  of  the  books  has  been  secured,  a  Balance 
Sheet  will  be  prepared  therefrom  in  the  usual  way.  And  with 
this  as  a  basis,  one  is  in  a  position  to  prepare  the  Statement 
of  Affairs.  The  assets  then  will  be  appraised  by  competent 
parties,  at  least  three  in  number,  and  with  this  information,  plus 
claims  which  have  come  in  from  creditors  in  the  meantime,  the 
receiver,  the  trustee,  the  assignee,  or  the  creditors,  from  the 
prepared  Statement  of  Affairs,  will  be  able  to  form  a  just  opinion 
as  to  how  much  may  be  expected  to  be  realized  from  the  assets 
upon  forced  sale  and  just  how  much  of  the  liabilities  may  be 
met. 

In  preparing  this  statement,  it  is  customary  to  follow  the  Eng- 
lish form  thereof.  The  English  Boards  of  Trade  and  the  English 
Bankruptcy  Laws  have  required  such  a  statement  for  years,  plus 


W 


Li 


I 


:i' 


\ 


I 


i   I 


I 


514 


ADVANCED  ACCOVNTING 


lees  t,h!  lifh  fr    "^  TuT^-    ^^^  ^""^^^^  f"™  °f  ^tet^-nent 

o^lJe  rLtt        KMV  *''  'f  ^''^  ^"'^  *'^^  ^''^'^  -"  deficiency 
on  the  right,  liabilities,  ordinarily,  will  exceed  assets,  and  in 

baricruptcy  proceedings  the  liabilities  must  be  presented  first 

When  preparing  such  a  statement  for  an  individual  or  for  a 

partnership,  one  should  remember  to  include  therein  the  r  per! 

Te  otr  iabt  iXr^'^Tt  ''^''"*"^^'  ^^=^"-  ^l'-  -tat- 
sonriH  h  '  ".'!'  ^'^^-    ^"  "  ^•'•^^  proprietorship,  per- 

Z^LT        T''  '"^^'^'^  ^''  "P°"  the  same  basis  since  the 

h  mseff tl  c!  ""r"^  "'  '  ''^"""  '^  '"  "°  ->^  different  from 
mse  f  ,n  the  capacity  of  proprietor.    I„  a  partnership,  although 

t^.e  bus,„ess  is  not  an  equity  separate  and  distinct  f  om  tZe 
who  compose  It,  one  must  keep  in  mind  the  rule  of  law  as"  gard' 
the  marshalline  of  assets      Rri^fl,,    *i      j    .  •  ""  ^egaras 

follows-     "lUaL    I  ^'  t''^  doctrine  is  state<i  as 

;7wTi  ^^'*'^''^"'"8  a^^ets  is  such  an  arrangement  of  funds 
a  swdl  enable  the  parties  having  equities  therein  to  receive  thet 
due  proportions,  notwithstanding  the   intervening  intei^stro 

lunds.     Ihis  doctrine  grows  out  of  tho  princiole  th«f  «  r.    / 
having  two  funds  te  satisfy  his  demand  shall  n^'Vh     elS^n' 
disappoint  a  party  who  has  only  one  fund."    In  ;ther  Irds  th  ' 
personal  creditors  of  partners  must  be  satisfied  out  o7  the  pi' 
sonal  assets  and  firm  creditors  out  of  the  firm  asspt«     T 

r,  'r  z  z",  "r  '^"°r'  "^'  °""^-  ^  "^i- 

aoie    lor   the    satisfaction    of   the    claims    ni   ih^        ^       V 
creditors.  ^^    ^^'^    partnership 

Illustrative  Problem:  Statement  of  Affair*;  pnri  n  c  • 
Account.    Problems  of  this  type  hale^tn  XinglTaS 
prominent  part  in  accounting  examinations;  hence  even  thoTI 

rS  ^oLT  "™'''"  "'^'^  '*^  ^"'""^  '^-^  *>-  -ciud^i 

a.ai„  .e  ^on...^.^^:^:^^^-:^::^:^^^. 

^ash, 

Land  and  buildings,  ^         500 .  00 

Mortgage  on  land  and  buildings  10 ,  000 .  00 

Plant  and  equipment  I  «,  000  00 

Creditors,    ^    ^         '  20,000.00 

69,400  00 


FIDUCIARY  STATEMENTS:  INSOLVENTS'  ESTATES      515 


Completed  contract  accounts  (losses). 

Capital, 

Uncompleted  contract  accounts  (outlay), 

Securities  acquired  in  settlements, 

Debtors '  accounts  for  completed  contracts. 

Expenses, 

Inventory  of  materials. 

Profit  and  loss  (deficiency), 


18,000.00 

30,000.00 
15,000.00 
6,000.00 
6,500.00 
2,000.00 
9,400  00 


50,000.00 


$117,400  00     $117,400.00 

The  sureties  on  the  unfinished  contracts  estimate  that  a  further  outlay 
of  $20,000.00  will  be  required  to  complete  the  work  and  realize  the  contract 
price  of  $40,000.00,  and  their  offer  to  take  over  the  materials  on  hand  for 
$  1 ,  500.00,  as  part  of  said  cost,  is  accepted  by  the  receiver.  Of  the  securities  ac- 
quired $5,000.00  is  pledged  to  secure  $11,000.00  due  creditors,  and  $10,000.00 
is  pledged  to  secure  $9,000.00  due  creditors.  The  company  owes  for  taxes  on 
real  estate  $100.00  and  for  salaries  and  wages  of  employees  $1,200.00,  which 
sums  do  not  appear  on  the  books.  The  company  has  discounted  customers' 
notes  for  $3,000.00,  of  which  subsequent  advices  indicate  that  $1,000.00  will  be 
dishonored,  and  a  debtor  owing  $1,500.00  on  unsecured  account  has  failed  and 
disappeared.  It  is  estimated  that  the  amount  realized  on  land  and  buildings 
will  be  sufficient  to  satisfy  the  mortgage  only,  and  that  plant  and  equipment 
will  realize  only  6  per  cent  of  the  book  value. 

Prepare  a  statement  of  affairs  and  deficiency  account.     (C.  P.  A. — Md.). 

Solviion  to  Problem. — In  the  solution  of  this  problem,  the  following  com- 
ments should  be  kept  in  mind: 

1.  The  problem  states  that "  plant  and  equipment  will  realize  only  6  per  cent 
of  the  book  value."  Undoubtedly,  there  has  been  a  misprint  in  that 
the  6  per  cent  should  be  60  per  cent.  No  matter  how  old  a  fixed  asset 
may  be,  it  ought  to  produce  at  least  60  per  cent  of  its  book  value  upon 
a  forced  sale  if  such  book  value  represents  actual  cost. 

2.  The  handhng  of  the  item  of  taxes  requires  some  explanation.  Taxes 
are  of  two  kinds: 

a.  Personal  property  taxes:  These  always  are  a  preferential  claim  to 
be  deducted  from  the  assets  in  the  same  manner  as  are  salaries  and 
wages. 

b.  Real  property  taxes:  These  are  a  hen  against  the  fixed  asset  to 
be  paid  from  the  proceeds  secured  from  the  forced  sale  of  such  asset. 
They  would  be  paid  first,  and  any  deficiency  in  favor  of  the  mort- 
gagee would  be  paid  with  the  other  unsecured  creditors  when  allowed 
by  the  Court. 

The  solution  follows: 


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CHAPTER  XVI 
FIDUCIARY  STATEMENTS  (CONTINUED) 

Introduction.— In  the  last  chapter  the  conditions  underlying 
insolvency  and  bankruptcy  were  discussed.  In  addition,  the 
following  matters  were  presented: 

1.  The  schedules  and  summary  by  means  of  which  the  liabil- 
ities and  assets  of  bankrupts  must  be  presented  to  the 
Court. 

2.  The  Statement  of  Affairs  and  accompanying  Deficiency 
Account  used  to  indicate: 

a.  Probable  realizable  financial  position:  the  Statement  of 
Affairs. 

b.  Reasons  for  insolvency:   the  Deficiency  account. 

In  the  present  chapter,  two  further  subjects  of  importfmce, 
relative  to  fiduciary-  accounting,  will  be  discussed: 

1.  The  procedures  necessary  to  keep  the  actual  accounts  of  a 
trusteeship. 

2.  The  statements  used  to  present  the  results  of  such  trustee- 
ship. 

Basic  Distinctions  Reviewed.— Certain  basic  definitions  in 
part  already  referred  to  must  be  reviewed  with  the  idea  of  re- 
membering them  in  connection  with  the  work  of  the  present" 
chapter: 

1.  Trustee.  A  person  to  whom  the  property  of  another  has 
been  conveyed  either  to  be  held  by  him  or  to  be  managed 
by  him  for  this  other  person. 

2.  Friendly  trustee.  A  trustee  may  be  appointed  by  the 
court,  or  he  may  be  appointed  by  agreement  between  the 
proprietors  and  the  creditors;  in  the  latter  case,  he  is  a 

friendly  trustee." 

3.  Receiver.  Two  kinds  of  trustees  are  appointed  by  the 
Court: 

518 


FIDUCIARY  STATEMENTS:   INSOLVENTS'   ESTATES      519 

a.  One  who  is  appointed  by  a  bankruptcy  Court,  and  who 
follows  a  person  temporarily  appointed  thereby  to  pre- 
serve the  estate  until  he  (the  trustee)  has  been  ap- 
pointed. The  person  who  has  thus  been  appointed 
temporarily  is  known  as  a  ''receiver  in  bankruptcy." 

b.  One  who  is  appointed  by  a  Court  of  Equity  when  an 
assignment  has  been  made  for  the  benefit  of  the  creditors. 
This  person  is  known  as  a  "receiver  in  equity."  In 
short,  when  a  "receiver"  is  spoken  of,  the  receiver  in 
equity  is  probably  the  type  to  which  reference  is  made. 

Receivership  Accounting.— The  accounting  for  receivers  in 
bankruptcy  is  simple,  in  that  such  a  receiver  is  appointed  only 
temporarily,  does  not  operate  the  business,  and  does  not 
liquidate;  he  merely  holds  the  assets  until  a  trustee  is  ap- 
pointed. 

The  accounting  for  a  trustee  in  bankruptcy  is  not  so  simple 
as  the  accounting  for  a  receiver  in  bankruptcy,  but  is  much 
simpler  than  the  accounting  for  a  receiver  in  equity.  His  ac- 
counting covers  the  realization  of  the  assets  and  the  liquidation 
of  the  liabilities;  infrequently,  he  will  keep  account  only  of 
receipts  and  disbursements. 

The  accounting  for  a  trustee  in  equity  should  follow  along  the 
same  basis  or  lines  as  the  accounting  made  use  of  under  normal 
conditions  of  operation ;  in  fact,  it  will  be  no  more  complex  than 
the  latter. 

Transactions  prior  to  the  trusteeship  should  be  distinguished 
clearly  from  those  taking  place  subsequent  thereto.  The  reasons 
therefor  may  be  enumerated  about  as  follows: 

1.  Receivership  in  equity.  The  activities  of  the  trustee  must 
be  set  forth  clearly  in  order  that  they  may  be  known 
definitely. 

2.  Receivership  or  trusteeship  in  bankruptcy. 

a.  The  result  of  the  activities  thereof  must  be  set  forth 
clearly  in  order  that  they  may  be  known  definitely. 

b.  The  assets  as  at  the  time  of  insolvency  must  be  ascer- 
tained because  these  represent  a  fund  out  of  which  the 
liabilities  must  be  paid,  subject  only  to  the  necessary 
expenses  of  the  asset  realization  activity. 


w 


520 


ADVANCED  ACCOUNTING 


n 


A  list,  therefore,  should  be  prepared,  as  at  the  beginning  of 
the  trusteeship,  of  the  assets  and  liabilities,  of  the  estate.  The 
list  of  assets  may  be  made  up  in  accord  with  the  values  ex- 
pressed upon  the  books  of  account,  or  the  values  may  be  in- 
cluded at  their  appraisal  worth  for  realization  purposes  if  the 
trusteeship  is  such  as  to  require  this,— as  where  the  realization 
is  to  proceed. 

The  liabilities  to  be  considered  in  this  type  of  estate  account- 
ing are  of  two  kinds: 

1.  Outside  creditors'  liabilities.  These  are  fixed  definitely  by 
the  publishing  of  a  required  notice  setting  a  specified  length 
of  time  during  which  such  claims  may  be  presented  and 
proved.  The  period  of  time  may  be  governed  by  the  Court, 
being  extended  thereby  from  time  to  time  but  when  once 
ended  it  may  be  assumed  that  the  liabilities  to  be  met  are 
only  those  which  have  been  proved. 

2.  Liabilities  incurred  by  the  trustee.  These  would  take  pre- 
cedence over  those  existing  at  the  moment  of  insolvency 
because  incurred  to  protect  the  original  creditors;  they 
could  not  have  been  incurred  if  these  subsequent  creditors 
had  rights  and  equities  no  better  than  those  of  the  original 
creditors. 

Therefore,  the  two  classes  of  liabilities  must  be  earmarked 
clearly. 

The  law  is  silent  as  to  the  manner  in  which  a  receiver  or 
trustee  shall  keep  his  accounts.  Basically,  he  must  charge  him- 
self with  what  he  takes  over  and  credit  himself  with  that 
which  is  disposed  of  by  himself.  The  old  books  may  be  con- 
tinued or  new  ones  may  be  used.  In  either  event,  the  identity 
of  the  original  items  must  be  preserved  so  that  confusion  will 
not  result  as  between  the  claims  of  different  rank.  Again,  after 
the  assets  have  been  appraised,  the  resulting  shrinkages  should 
be  written  off  against  the  capital;  .^kewise,  the  other  nominal 
elements  should  be  written  off  there  against.  T^e  purpose  here 
contemplated  is  to  express  upon  the  books  eventually  only  the 
inventory  value  of  the  assets  plus  the  liabilities. 

Realization  and  Liquidation.— When  the  assets  of  an  estate, 
business  or  otherwise,  are  converted  into  cash,  and  this  cash  is 


FIDUCIARY  STATEMENTS:   INSOLVENTS'  ESTATES      521 


applied,  after  the  costs  of  the  conversion  have  been  deducted,  to 
liquidating  the  claims  against  such  estate,  a  "realization  and 
liquidation"  has  taken  place.  In  the  case  of  a  receivership  or 
trusteeship,  three  degrees  of  possibility  exist  relative  to  the 
activities  incident  thereto: 

L  The  affairs  may  be  wound  up  fully,  a  complete  piecemeal 
realization  of  its  assets  being  involved. 

2.  The  affairs  may  be  wound  up  fully  but,  instead  of  a  piece- 
meal realization  of  the  assets,  the  enterprise  is  sold  as  a 
going  concern. 

3.  The  affairs  may  be  wound  up  partially  and,  .also,  be 
partially  continued  in  a  going  manner  so  that,  eventually, 
the  enterprise  will  be  restored  to  its  owners  in  a  healthy 
condition.  This  is  a  common  occurrence  and  would  arise 
where  a  friendly  trusteeship  comes  into  existence. 

The  first  two  possibilities  do  not  differ  materially  one  from 
the  other,  for  the  present  purpose,  in  the  accounting  required, 
and  therefore  may  be  referred  to  as  a  "simple  realization  and 
liquidation."  The  third  possibility  differs  greatly  from  the  other 
two,  and  therefore  must  be  considered  separately;  it  involves 
something  more  than  a  simple  realization  and  liquidation. 

In  describing  the  procedures  made  use  of  in  connection  with 
the  present  type  of  fiduciary  accounting,  a  division  is  indicated 
along  the  lines  mentioned  immediately  above: 

1.  The  simple  realization  and  liquidation. 

2.  The  realization  and  liquidation  accompanied  by  activities 
of  trading  or  operation. 

Simple  Realization  and  Liquidation. — This  may  involve  one 
of  two  elements  already  mentioned: 

1.  The  element  of  insolvency,  as  where  a  concern  is  bankrupt 
and  must  be  wound  up  fully  for  the  benefit  of  creditors. 

2.  The  element  of  mere  dissolution,  as  where  a  partnership 
is  to  be  dissolved,  the  firm,  for  some  reason  or  other,  going 
out  of  business. 

In  either  event,  two  methods  present  themselves  as  to  the 
manner  in  which  the  accoimts  may  be  carried  upon  the  books 
thereunder: 

1.  Keep  them  uniform  as  nearly  as  possible  with  those  pre- 


522 


ADVANCED  ACCOUNTING 


■  A 


-m 


I 


viously  kept.  As  assets  are  converted  into  cash,  the  Cash 
account  will  be  debited  and  the  asset  accounts  affected  will 
be  credited.  As  cash  payments  are  made  to  creditors,  the 
Cash  account  is  credited  and  the  liability  accounts  affected 
are  debited.  WTien  all  the  assets  have  been  realized  upon, 
a  balance  remaining  in  any  asset  account  represents  a  reali- 
zation loss,  whereas  a  remaining  balance  in  any  liability 
account  represents  a  loss  to  creditors.  The  closing  of  the 
accounts  remaining  open  depends  upon  whether  the  business 
IS  that  of  a  sole  trader,  a  partnersliip,  or  a  corporation: 

a.  Sole  trader.  Close  remaining  open  accounts  into  pro- 
prietor's Capital  account. 

b.  Partnership.  Charge  losses  against  the  partners'  Capital 
accounts  in  the  proportions  in  which  they  share  profits 
and  losses. 

c.  Corporation.  Debit  the  Capital  Stock  account  for  the 
shares  of  capital  stock. turned  in  by  the  stockholders  for 
cancellation,  and  close  the  remaining  accounts  through 
Surplus  account. 

The  losses  due  to  realization,  therefore,  are  chargeable  to 
the  Capital  account  of  a  sole  trader,  to  the  Capital  accounts 
of  the  partners,  and  to  the  Surplus  account  of  a  corporation. 
The  balances  remaining  in  the  liability  accounts,  if  the 
realization  is  conducted  at  a  loss,  in  the  case  of  a  sole 
trader,  will  equal  in  amount  the  debit  balance  remaining 
in  his  Capital  account;  in  the  case  of  a  partnership,  the 
amount  of  the  unliquidated  liabilities  will  offset  the  debit 
balances  remaining  in  the  partners'  Capital  accounts;  and 
in  a  corporation  these  unliquidated  liabilities  will  be  offset 
by  a  debit  balance  in  the  Surplus  account. 
2.  The  assets  and  liabilities  may  be  consolidated  in  an  account 
titled  "Realization  and  Liquidation."  The  operation  of  this 
account  probably  has  been  described  in  the  students'  work 
in  connection  with  partnerships.  If  used,  the  account  is 
debited  with  the  amounts  of  the  various  assets,  the  respec- 
tive asset  accounts  being  credited;  it  is  credited  with  the 
liabilities,  the  respective  liability  accounts  being  debited. 
The  balance  of  the  account,  if  a  debit,  shows  the  amount  by 


FIDUCIARY  STATEMENTS:  INSOLVENTS'  ESTATES      523 


which  the  asset  values  exceed  the  liabilities;  and  if  the 
balance  is  a  credit,  such  credit  indicates  the  deficiency  by 
which  the  liabilities  are  greater  than  the  assets.  If  some 
cash  is  on  hand,  the  item  may  be  either  included  or  ex- 
cluded from  the  account;  it  may  be  excluded  because  it  is 
in  its  ultimate  realizable  form.  It  is  advisable,  however, 
to  include  the  item  and  then  immediately  make  an  entry 
to  take  it  therefrom,  as  under: 


Trustee's  Cash  Account, 

To — Realization  and  Liquidation  Account, 


S  i 


$  i 


The  detail  accounts  receivable  and  payable  should  be 
carried  in  their  respective  subsidiary  Ledgers,  the  total 
amounts  thereof  only  being  shown  in  the  Realization  and 
Liquidation  account  as  controls  over  such  subsidiary 
Ledgers.  As  cash  is  received  from  the  realization  of  as- 
sets, the  Trustee's  Cash  account  would  be  charged  and  the 
Realization  and  Liquidation  account  credited.  As  liabilities 
are  liquidated,  the  Realization  and  Liquidation  account  is 
charged  and  the  Trustee's  Cash  account  is  credited.  When 
expenses  of  realization  are  paid,  the  same  entry  would  be 
made,  as  just  above.  When  the  realization  and  liquidation 
has  been  completed,  the  balance  in  the  account  of  that 
name  shows  the  net  profit  or  loss  resulting  from  the  reali- 
zation; usually,  the  balance  will  indicate  a  loss. 

It  is  not  usually  desirable  to  show  such  losses  or  profits,  under 
either  case,  in  a  Profit  and  Loss  account.  It  should  be  remem- 
bered that  the  latter  account  shows  the  results  of  the  operation 
of  a  business.  In  this  winding-up  process  no  business  operation 
is  contemplated;  therefore,  the  results  of  such  wind-up  should 
not  be  entered  in  that  summary  account,  but  in  what  is  known 
as  a  Realization  and  Liquidation  account.  When  a  partnership 
is  dissolved,  for  example,  the  wind-up  may  continue  for  a  long 
period  of  time,  for  months. 

Under  either  the  first  or  second  cases  described  above,  it  would 
be  customary  to  present  the  results  of  the  trusteeship  in  the  form 
of  a  statement,  this  being  titled  ''Statement  of  Realization  and 
Liquidation."  This  statement  will  be  described  later  after  cer- 
tain other  matters  have  been  considered. 


I 


524 


ADVANCED  ACCOUNTING 


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Realization  and  Liquidation  Accompanied  By  Activities 
of  Trading  or  Operation. — Under  this  possibility,  the  procedure 
outlined  above  in  the  last  section  would  be  supplemented  by  the 
addition  and  maintenance  of  ordinary  trading  accounts.  These 
latter  would  be  kept  entirely  separate,  perhaps  in  a  distinct  set 
of  records  or,  as  is  more  often  the  case,  by  using  the  Realization 
and  Liquidation  account  as  already  shown  plus  a  list  of  accounts 
arising  because  of  the  added  activity. 

Again,  for  example,  suppose  a  business  has  become  merely 
financially  embarrassed,  without  being  actually  insolvent  as 
contemplated  under  the  bankruptcy  act.  The  creditors  are  in- 
formed of  the  existing  conditions  and  are  asked  to  render  what- 
ever assistance  they  can.  As  a  rule,  the  creditors  will  rise  to 
the  occasion  in  order  to  protect  their  interests.  If  so,  some  out- 
sider, perhaps  one  of  the  creditors,  will  assume  charge  of  affairs. 
As  a  trustee,  this  outsider  is  in  exactly  the  same  position  as  one 
who  is  going  to  discontinue  business  except  that  he  is  going  to 
operate  the  concern,  convert  some  of  its  assets  into  cash,  and 
liquidate  the  claims  of  creditors.  When  this  purpose  has  been 
accomplished,  the  business  will  be  returned  to. its  proprietors. 
Hereunder,  are  two  distinct  propositions  over  which  control  must 
be  kept: 

1.  The  realization  and  liquidation  proper. 

2.  The  operations  of  the  trustee. 

The  result  of  each,  if  possible,  should  be  secured  separately, 
although  it  may  not  be  so  done  as  where  only  the  combined 
result  is  set  out. 

Since  the  goods  inventory  must  be  used  by  this  added  activity, 
one  of  the  first  things  to  do  would  be  to  credit  its  amount  to 
the  Realization  and  Liquidation  account  and  charge  a  properly 
earmarked  inventory  account  therewith. 

The  result  of  this  added  activity  should  be  set  forth,  prefer- 
ably, in  a  regular  Profit  and  Loss  account,  and  the  balance 
thereof  carried  over  into  the  Realization  and  Liquidation  account 
therein  to  be  combined  with  the  result  of  the  regular  realization 
and  liquidation.  Periodically,  statements  would  be  prepared  to 
show  the  net  results  both  as  to  the  realization  and  liquidation 
proper  and  as  to  the  added  activity;  these  statements  may  be 
prepared  either  separately  or  be  consolidated  into  one  with 


FIDUCIARY  STATEMENTS:  INSOLVENTS'  ESTATES      525 


separate  sections  which  would  correspond  to  the  separate  state- 
ments, and  at  the  end  of  which  would  be  shown  in  summary  form 
the  combined  result  of  each  section.  Frequently,  a  Balance 
Sheet  will  be  submitted  in  addition. 

Statement  of  Realization  and  Liquidation. — This  statement 
has  been  referred  to  above  from  time  to  time  in  connection  with 
the  two  types  of  fiduciary  accounting  described.  It  is  necessary 
now  to  consider  this  statement  briefly  in  order  to  round  out  the 
theoretical  discussion  of  the  present  chapter  and  to  lead  up 
properly  to  the  illustrative  problems  solved  herein. 

Basically,  the  statement  covers  the  transactions  incident  to 
the  liquidation,  being  arranged  in  such  a  manner  as  to  acquaint 
the  reader  thereof  with  their  nature.  In  fact,  it  is  prepared 
exactly  along  the  lines  indicated  in  the  discussion  above  con- 
cerned with  "simple  realization  and  liquidation." 

When  a  simple  realization  and  liquidation  is  contemplated,  the 
statement  is  not  difficult  to  prepare.  Its  sections  coincide  with 
the  groupings  of  the  items  found  within  the  Realization  and 
Liquidation  account,  if  the  latter  be  used.  Because  of  this 
similarity,  it  was  deemed  unnecessary  to  present  a  form  of  such 
account  as  part  of  the  previous  discussion. 

The  statement  often  is  referred  to  as  an  account  since,  usually 
it  appears  in  account  form  but,  naturally,  it  is  not  an  account  in 
the  strict  meaning  of  the  term.  If  the  Statement  of  Affairs  is 
an  estimate  or  prophecy, — ^what  it  is  hoped  may  be  done, — ^the 
Realization  and  Liquidation  statement  (or  account)  becomes 
the  test  by  means  of  which  the  accuracy  therein  displayed  is 
measured.  For  a  simple  realization  and  liquidation,  the  form 
thereof,  would  be  about  as  follows : 

FIRM   OF  BLANK   BROTHERS 


Realization  and  Liquidation  Account  as  of 


Assets  to  be  Realized  Upon: 

In  detail. 
Additional  Assets  Discovered: 

In  detail. 
Liabilities  Discharged: 

In  detail. 
Liabilities  not  Discharged: 

In  detail. 


Liabilities  to  be  Discharged: 

In  detail. 
Additional  Liabihties  Discovered: 

In  detail. 
Proceeds  from  Realization  of  Assets: 

In  detail. 
Assets  not  Realized  Upon. 

In  detail. 


H 


526 


"Hi' 


i 


ADVANCED  ACCOUNTING 


Expenses  of  Realization  and  Liquidation : 

In  detail. 
Balance,    (if   debit)    Net   Profit   on     Balance,    (if    credit)    Net   Lo8a_on 
Realization  and  Liquidation.  Realization  and  Liquidation. 

Scrutiny  of  this  statement  will  show  that,  if  properly  prepared, 
one  can  trace,  for  example,  any  asset  from  its  original  amount 
down  through  its  increase  or  decrease  during  liquidation,  pro- 
ceeds from  the  sale  thereof,  and  resulting  profit  or  loss  thereon. 

When  a  realization  and  liquidation  is  accompanied  by  activi- 
ties of  trading  or  operation,  the  situation  encountered  is  an 
awkward  one  to  handle  if  clearness  is  desired.  The  statement 
prepared  under  this  condition  may  assume  either  one  of  the  two 
following  forms,  the  writer's  preference  being  the  second  one. 

The  first  form  suggested  is  similar  to  the  one  shown  above 
with  its  scope  slightly  extended.  A  comparison  of  the  two  forms, 
one  with  the  other,  will  show  wherein  exists  the  difference  be- 
tween them.  The  first  type  of  statement,  showing  section  head- 
ings only,  is  given  below: 

FIRM   OF  BLANK  BROTHERS 

Realization  and  Liquidation  Account  as  of 

Assets  to  be  Realized  Upon. 
Additional  Assets  Discovered. 
Liabilities  Discharged. 
Supplementary  Charges. 
Liabilities  not  Discharged. 
Net     Profit     on     Realization 
Liquidation. 


Liabilities  to  be  Discharged. 
Additional  Liabilities  Discovered. 
Proceeds  from  Realization  of  Assets. 
Supplementary  Credits. 
Assets  not  Realized  Upon. 
and     Net     Lobs     on     Realization     and 


Liquidation. 


Although  the  above  form  is  the  one  usually  made  use  of, 
seemingly  it  violates  certain  principles  of  accounting  in  its  set- 
up in  that  the  trustee  is  chargeable  thereon  with  dissimilar 
elements  at  one  and  the  same  time,  as  with  both  profits  and 
losses.  To  avoid  this  criticism,  the  statement  may  be  prepared 
so  that  an  absolute  divorce  is  made  between  the  realization  of 
the  original  estate  and  the  operations  of  the  trustee.  Two 
separate  results  are  secured  thereunder: 

1.  Loss  on  realization  and  liquidation. 

2.  Profit  on  the  trading  activities  of  the  trustee. 

The  determination  of  each  of  these  results  becomes  the  province 


FIDUCIARY  STATEMENTS:  INSOLVENTS'  ESTATES      527 

of  separate  sections  of  the  statement.  And  these  two  results  are 
brought  together  in  a  third  portion  of  the  statement  in  summary 
form,  the  resulting  balance  therein  being  the  net  profit  (or  loss) 
of  the  trusteeship  period.  It  is  believed  that  this  method  of 
solution  follows  more  accurately  the  practical  way  in  which  an 
actual  receivership  is  carried  out  than  does  the  method  indicated 
by  the  pro  forma  statement  to  which  reference  already  has  been 
made.  A  form  of  this  type  of  statement  is  not  submitted  at  this 
point,  because  it  is  made  use  of  in  the  solution  of  the  second 
problem  following. 

Illustrative  Problems  and  Solutions.— In  concluding  the 
discussion  of  the  present  chapter,  three  problems  are  given,  each 
of  which  is  solved  in  accord  with  the  principles  advanced  above. 
The  first  problem  illustrates  the  closing  process  involved  in 
handling  a  simple  realization  and  liquidation  upon  the  books; 
it  is  out  of  this  simple  process  that  the  Statement  of  Realization 
and  Liquidation  has  been  evolved. 

The  second  and  third  problems  illustrate  the  Statement  of 
Realization  and  Liquidation  where  the  activity  is  accompanied 
by  trading  or  operation.  Since  the  statement  is  much  more  diffi- 
cult to  prepare  under  this  second  type  of  realization  activity,-— 
where  a  rehabilitation  is  contemplated  of  a  concern  financially 
embarrassed,— than  under  the  first  type  or  simple  realization 
process,  two  problems  are  solved  instead  of  just  one. 

Problem  1.— On  May  14,  1920,  a  fire  destroyed  the  premises  at  936 
Osgood  Street,  rented  by  John  Smith  and  used  by  him  a^  a  clothing  store. 
His  stock  of  merchandise  and  the  store  equipment,  together  with  a  Ford 
dehvery  wagon  kept  in  a  rear  shed,  were  insured  for  $1,500.00.  With  the 
exception  of  the  Ford  and  the  office  safe,  everything  was  either  totaUy 
destroyed  or  rendered  comparatively  useless  by  fire  and  water. 

Because  of  the  fire  and  the  small  amount  of  insurance  carried,  Mr.  Smith 
practically  was  ruined  and,  in  order  to  avoid  bankruptcy  proceedings,  he 
called  his  creditors  together,  showed  them  the  condition  of  his  affairs,  and 
then  left  the  matter  entirely  in  their  hands  for  disposition.  The  creditors 
agreed  that  the  business  should  be  wound  up  under  the  direction  of  a  trustee 
appointed  by  themselves.  The  latter  was  directed  to  collect  the  money 
from  the  insurance  company,  reaUze  upon  the  salvaged  stock  and  effects, 
collect  what  he  could  of  the  outstanding  debts,  pay  the  expenses  incidental 
to  windmg  up  the  business,  and  distribute  the  balance  pro  rata  among  the 
creditors.  The  agreement  was  signed  by  the  debtor  and  his  creditors  on 
both  accounts  and  notes  payable,  and  the  trustee  then  took  possession. 


528 


ADVANCED  ACCOVNTING 


:  1 


•)(! 


^1 


The  books  were  taken  from  the  safe  and  W(»re  written  up  to  and  including 
May  20,  after  which  the  following  statement  was  prepared  therefrom: 

JOHN   SMITH 


Statement  of  Assets  and  Liabilities  as  of  May  20,  1920 

Assets 

Cash  on  Deposit, 

$     579.80 

Merchandise, 

6,230  25 

Notes  Receivable, 

406.58 

No.  1, 

iSOO  00 

No.  2, 

206.58 

Total  (as  above). 

•406  58 

Accounts  Receivable, 

1,475.85 

A.  Roth, 

$286.20 

B.  Walker, 

227  80 

C.  Sobel, 

689.85 

D.  Anthony, 

70.50 

E.  Worms, 

201  50 

Total  (as  above), 

sets. 

$1,475  85 

Total  Current  Ass 

$8,692.48 

Automobile, 

$140  00 

Store  and  Office  Equipment, 

513.00 

663.00 

Total  Assets, 

$9,345.48 

1        ■  .1     — t 

Liabilities  and  Capital 

Notes  Payable, 

$1,315.00 

Ross  Brothers, 

$     815  00 

Bentley  Sidle  Co., 

600  00 

Total  (as  above). 

$1,315.00 

Accounts  Payable, 

4,962.80 

A.  Henry, 

$     360  00 

C.  Krafer, 

140.00 

B.  Cohn, 

640.50 

D.  Currie, 

740  00 

Mordant  Co., 

1,875.00 

Cable  Co., 

1.207.10 

Total  (as  above), 

$4,962.80 

Total  Liabilities, 

$6,277.80 

John  Smith,  Capital, 

3,067.68 

Total  Liabilities  and  Capital, 

$9,345  48 

The  wind  up  of  the  business  was  concluded  on  May  31,  and  the  transac- 
tions of  the  trustee  from  May  20  to  May  31  were  as  follows: 

1.  Wrote  each  debtor  offering  to  settle  at  a  discount  of  10  per  cent,  a 
receipt  in  full  to  be  given  for  a  return  settlement. 

2.  Received  from  the  insurance  company  amount  of  insurance  in  full 


FIDUCIARY  STATEMENTS:  INSOLVENTS'  ESTATES      529 

which  wa«  pro-rated  as  follows:  merchandise,  $1,117.00;  store  and 
office  equipment,  $383.00. 

3.  Advertised  sale  of  damaged  stock  and  effects  by  auction.  Paid 
therefor  to  the  local  papers,  $122.50. 

4.  Received  of  A.  Roth,  $257.58,  and  from  C.  Sobel,  $620.87,  both  in 
full  of  account. 

®'  f^''ni'"'/"*°.*°  ^-  ^°™"  ^°'  *^'^'  ""'^  t*"*  ««f«  t«  A.  Sorensen  for 
g^yu.uu,  for  which  cash  was  received. 

6.  Received  from  B.  Walker  sight  draft  on  the  City  Bank  for  $205.00 
m  full  discharge  of  account.  Drew  on  E.  Worms,  at  his  request, 
and  allowed  him  a  discount  of  $20.15.  It  wa^  ascertained  that 
D  Anthony  had  left  the  city  with  nothing  but  debts  behind,  where- 
abouts unknown. 

^'  I^LT.^'r  f!  ""^^^^^  ^^■^^'  ^^^  a^^tioneer  turned  in  his  check  for 
$450  25,  he  deducting  $50.00  for  his  charges.  Proceeds  were  prorated 
as  follows:  merchandise,  $460.25;  store  and  office  equipment   $40  00 

8.  Paid  for  clerk  hire,  $30.00;  and  for  signs,  hand-biUs,  and  expenses 
mcidental  to  auction  sale,  $46.90. 

in*  ?'Tr*?^u^v  "''*^'  ^^^^'vaWe  with  City  Bank  receiving  $360.00  net. 

10.  Paid  the  liabilities  to  creditors  pro  rata  with  the  cash  on  hand  after 
deducting  fees  and  expenses  of  trustee  in  the  amount  of  $328.77  and 
closed  the  remaining  accounts.  ' 

Make  entries  in  journal  form  necessary  to  cover  the  above 

Solution  to  Problem  l.-The  entries  in  journal  form,  covering  the  require- 

Zr^V  r  t  ^'''i^^''"'  ^''  ^^'''  ^"*^^-     I*  i«  ^«""^«d  that,  at  the 

time  of  the  take  over,  the  Ledger  account  balances  were  in  agreement  with 
the  amounts  found  upon  the  statement. 

1.  Cash  on  Deposit,  $1,500.00 

To-Merchandise,  $1,117  00 


Store  and  Office  Equipment, 

To  record  cash  received  from  insur- 
ance company. 
Realization  and  Liquidation  Account, 
To — Cash  on  Deposit, 

Advertising  bills  paid. 
Cash  on  Deposit, 

Reahzation  and  Liquidation  Account, 
To — Accounts  Receivable, 

Collections  as  follows: 

Cash 


383  00 


$122.. 50 


$1,264.80 
211.05 


$122  50 


$1,475.85 


A. 
B. 
C. 
D. 


Roth, 
Sobel, 
Walker, 
Worms, 


E.  Anthony, 


Total, 


$  257.58 
620.87 
205.00 
181.35 

Bad  Debt 

$1,264.80 

211  015 

$1,475.85 


Discount 
$28.62 
68.98 
22.80 
20.15 
70^50 

$211  05 


' 


$140.00 
90.00 


$450.25 
50.00 


$460.25 
40.00 


530  ADVANCED  ACCOUNTING 

4.  Cash  on  Deposit,  $140.00 

Realization  and  Liquidation  Account,  90 .  00 

To — Automobile, 

Store  and  office  Equipment, 

Cash  collected  from  sale  of  above  assets. 
6.  Cash  on  Deposit, 

Realization  and  Liquidation  Account, 
To — Merchandise, 

Store  and  Office  Equipment, 

Receipts  from  auction  sale,  $50.00 
being  auctioneer's  charges. 

6.  Realization  and  Liquidation  Account, 

To — Cash  on  Deposit, 
Expenses  paid. 

7.  Cash  on  Deposit, 
Realization  and  Liquidation  Account, 

To — Notes  Receivable, 
Notes  discounted. 

8.  Realization  and  Liquidation  Account, 

To — Cash  on  Deposit, 

Charges  and  expenses  of  trustee. 
At  this  point  the  realization  entries  havt»  been  completed.     It  remains 
now  only  for  the  trustee  to  pay  off  the  debt**,  he  having  $3,766.68  on  hand 
with  which  to  do  so,  this  being  sufficient  to  pay  $.60  on  the  dollar. 


$76.90 


$360.00 
46.58 


$328.77 


$76.90 


$406.58 


$328.77 


9.  Accounts  Payable, 

A.  Henry, 

C.  Krafer, 

B.  Cohn, 

D.  Currie, 


Total 

360  00 
140.00 
640.50 
740.00 


$4,962.80 


Mordant  Co.,     1 ,875 .  20 
Cable  Co.,  1,207.10 


60  per  cent 

$     216.00 

84.00 

384  30 

444.00 

1,125.12 

724.26 


N! 


II' 


$4,962.80    $2,977.68 


$815.00 
500.00 


$489.00 
300.00 


$1,315.00     $3,766.68 


11 


Total, 
Notes  Payable, 

Ross  Bros., 
Bentley  S.  Co., 

Total, 
To — Cash  on  Deposit, 

Reahzation  and  Liquidation  Account 

10.  Reahzation  and  Liquidation  Account, 

To — Merchandise, 
To  close. 

11.  John  Smith,  Capital, 

To — Realization  and  Liquidation  Account, 
To  close. 


$1,315.00 


$4,653.00 


$3,067.68 


$3,766.68 
2,611.12 

$4,653.00 


$3,067.68 


Illustrative  Problem  2. — Although  this  is  one  of  the  earlier  C.  P.  A.  prob- 
lems and,  because  of  its  type,  has  been  used  by  certain  others  for  illustrative 


FIDUCIARY  STATEMENTS:   INSOLVENTS'   ESTATES      531 

purposes,  the  problem  is  so  well  adapted  as  an  illustration  of  the  application 
of  present  prmciples  that  the  writer  has  made  use  of  it  again;  however,  it  is 
believed  that  the  method  of  solution  adopted  does  not  conflict  in  any  way 
with  those  already  propounded  by  others. 

The  affairs  of  Peter  Post,  a  manufacturer,  were  in  a  very  critical  condition, 
for  although  he  had  an  unimpaired  investment  of  $62,500.00,  and  his  books 
showed  a  clear  increase  of  $6,022.00,  he  owed  his  trade  creditors  $25,289  00 
and  had  only  $265.00  in  cash  and  $4,062.00  in  receivable  book  accounts  on 
which  to  rely  for  funds.  The  rest  of  his  business  estate  was  tied  up  in  the 
following  chattels,  which  he  had  acquired  in  an  effort  to  keep  pace  with  a 
business  growth  that  had  outrun  his  capital :  Machinery  and  tools,  $31,497.00; 
raw  materials,  $18,838.00;  partly  made  goods,  $31,562.00,  and  finished  wares,' 
$7,587.00.  It  was  also  necessary,  in  order  to  continue  operations,  to  have 
immediate  cash  for  pay  rolls  and  incidental  expenses. 

A  meeting  of  his  principal  creditors  was  called  and  as  it  appeared  that 
the  business  was  well  established,  profitable  and  had  a  sure  and  growing 
market,  they  decided  to  advance  him  $6,000.00  in  cash  for  immediate  needs 
and  extend  his  credit  in  a  sufficient  amount  to  permit  of  the  purchase 
of  necessary  materials  and  generally  to  continue  operations  till  the  present 
stock  of  materials  could  be  made  up  and  realized  on. 

In  order  to  insure  the  proper  application  of  the  funds  and  credit  so  pro- 
vided, a  trustee  was  appointed  to  administer  the  finances  till  the  creditors* 
claims  were  satisfied,  at  which  time  the  control  would  revert  to  the  proprietor. 

The  subsequent  operations  under  the  trusteeship  were  as  follows:  Cash 
paid  for  labor,  $15,725.00;  for  expenses,  $5,430.00;  for  additional  tools, 
$750.00;  purchases  on  book  account,  charged  to  materials,  $6,300.00,  to  ex- 
penses, $15,000.00;  sales  on  book  account,  $72,300.00;  loss  on  collection  of 
book  debts,  $380.00;  personal  drawing  of  Peter  Post,  $3,500.00. 

The  unliquidated  values  at  the  close  of  the  trusteeship  were  as  follows: 
Inventory  of  raw  materials,  $5,000.00;  finished  wares,  $27,900.00;  accounts 
receivable  outstanding,  $3,382.00,  and  accounts  payable,  $89.00. 

Prepare  with  due  regard  to  the  grouping,  order  and  arrangement  of  the 
Items,  as  best  calculated  clearly  to  display  the  facts,  (a)  realization  and 
liquidation  account,  (b)  trustee's  cash  account,  (c)  balance  sheet  of  business 
as  restored  to  Peter  Post. 

Solution  to  Problem  2  —It  would  seem  that  the  first  thing  to  do  in  com- 
mencing the  solution  of  this  problem  is  to  prepare  a  Balance  Sheet  for 
Peter  Post  as  at  the  moment  his  affairs  were  turned  over  to  the  trustee. 
By  so  doing,  a  definite  point  of  commencement  is  secured  from  which  to 
proceed.     This  statement  is  as  follows: 

PETER  POST 
Balance  Sheet  as  of 


(Date  when  affairs  turned  over  to  trustees) 

Assets 
Cash,  

Accounts  receivable, 


$        265.00 
4,062.00 


532 


ADVANCED  ACCOUNTING 


FIDUCIARY  STATEMENTS:  INSOLVENTS'  ESTATES     533 


I 


I 


i 


\ 


i 


Finished  wares, 
Partly  made  goods, 
Raw  materials, 
Machinery  and  tools, 


Liabilities 


7,587.00 
31,562.00 
18,838.00 
31,497.00 

$93,811.00 


81 


s  s  s 


Trade  creditors, 

Capital, 

Surplus, 


125,289.00 
$62,500.00 

6,022.00       68,52200 

$93.811.00 

The  next  step,  which  contemplates  the  first  requirement  of  the  problem, 
is  to  prepare  the  Realization  and  Liquidation  account.  It  is  presented 
on  page  533. 

The  second  requirement  of  the  problem  is  to  prepare  the  trustee's  Cash 
account.  This  means  exactly  what  the  term  "Cash  account"  implies,— 
a  record  of  the  receipts  and  disbursements  of  cash,  in  this  case,  as  made  by 
the  trustee.  The  opening  balance  represents  the  cash  turned  over  by  the 
estate  to  the  trustee.  Originally,  as  per  the  first  section  of  the  Realization 
and  Liquidation  account,  this  amount  is  shown  as  an  asset  to  be  realized 
upon.  When  turned  over  to  the  trustee,  it  is  an  asset  realized,  being  shown 
as  such;  the  Cash  account  follows: 

Trustee's  Cash  Account 


19— 


19— 


Balance  taken  over,  $      265 .  00 
Loan    from    trade 
creditors,  6,000.00 

A  ccounts  receivable,  72 ,  600 .  00 


Materials, 

Labor, 

Expenses, 

Tools, 

Accounts  payable 

(includes      loan 

from   creditors   of 

$6,000.00), 

Drawings, 

Balance, 


$  6,300.00 

15,725.00 

20,430.00 

750.00 


Balance, 


$78,865.00 
$      960.00 


31.200  00 

3,500.00 

960.00 

$78,865.00 


The  third  and  last  requirement  of  the  problem  is  to  prei)are  a  Balance 
Sheet  of  the  business  as  restored  to  Peter  Post.  Although  the  ordinary 
simple  account  form  of  statement  would  be  sufficient  for  the  purpose,  the 
comparative  form  of  statement  seems  more  desirable  in  that  by  such  use 
one  may  secure  a  ready  comparison  between  the  two  Balance  Sheets,  one 
just  before,  and  one  just  after,  the  trusteeship.  The  Comparative  Balance 
Sheet  is  shown  on  page  534. 


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ADVANCED  ACCOUNTING 

PETER  PgST 

CiOMPABATTVB  BaLAWCK  ShEBT 

as  of ■ 


Assets 


End 

I      NO.OO 

3,382.00 
27,800.00 

5,000.00 
32.247.00 


Beginping 

$      265.00 

4.062.00 

7.587.00 

31.562.00 

18.838.00 

31.497.00 


Irierease 
$      095.00 

20.313.00 


109.489  00    $93,811  00 


$        89.00 

62,500  00 

6,il00.00 

$69,489.00 


$25,289.00 

62.500.00 

6,022.00 

$93,811.00 


780.00 

$21,758.00 

24.322.00 

$46,0K0  00 


_$878^ 

$878.00 

24,322.00 

$25,200.00 


Decrease 

t      680  00 

31.562.00 
13.838.00 

$46,080.00 

M6.080.00 
$25,200.00 


$25,200  00 


$25,200.00 


Cash. 

Accounts  Receivable, 
Finished  Wares. 
Partly  Made  Goods. 
Raw  Materials, 
Machinery  and  Toola 

Total  Assets, 
Net  Decrease  in  Assets, 

Liabilities  and  Capital 
Trade  Creditors,  * 

Capital  Account,  Peter  Post, 
Surplus, 

Total  Liabilities  and  Capital, 
Net  Decrease  in  Liabilities  and  Capital, 

Analysis  of  Net  Worth  of  Peter  Poet 
Caintal,  Beginning  of  Trusteeship,  $62,500  00 

Add—  Initial  Surplus,  g  q22  00 

Baluice,  Net  Worth  Beginning  of  Trustee- 

■*"P'  $68,522.00 

Add—  Net  Profit  on  Trustee 

ship.  $4.378  00 

I^»—  Drawings.  3.500  00     878.00 

Balance,  Net  Worth  End  of  Trusteeship,     $69,400.00 

Problem  3.-Me8srs.  Green  &  Sharp,  having  given  the  fim,  notes  to  a 
fnendly  company  as  an  accommodation,  became  embarrassed  through 
failure  of  payee  and  appointed  a  trustee  to  realize  and  liquidate  The 
foUowmg  IS  a  statement  of  their  condition,  January  1,  19—. 

Assets 
Cash  on  hand  and  in  bank, 
Stock  of  goods, 
Real  estate, 
Bills  receivable. 


Book  debts  receivable  (includes  accommodation  account  of 
payee,  $58,000.00), 

Liabilities 
Mortgage  on  real  estate, 

Mortgage  interest  accrued  to  January  1,  19—, 
Taxes, 

Book    debts    payable    (includes   accommodation   paper   of 

payee,  $58,000.00), 

Bills  payable, 

H.  Maxwell,  special  partner, 

S.  Green,  capital, 

J.  Sharp,  capital, 


500.00 

20,000.00 

25,000.00 

5,000.00 


62,000.00 


$112,500.00 

I  6,000.00 
250.00 
375.00 

61,550.00 
1,000.00 
10,000.00 
20,325.00 
14,000.00 


$112,500.00 


FIDUCIARY  STATEMENTS:  INSOLVENTS'  ESTATES      535 


$  70,000.00 

108,000.00 

2,000.00 

10.000.00 


The  following  is  a  memorandum  of  the  trustee's  transactions  for  the 
ensuing  year: 

Purchases  to  complete  contract  orders, 

Sales  for  year  for  cash. 

Uncollected  accounts 

Stock  of  goods  on  hand,  Deceml)er  31, 

Bills  receivable  collected  at  a  loss  of  $600 .  00 

Book  debts  receivable,  collected  $3,600.00;  balance  lost. 

Received  75  per  cent  in  full  settlement  of  accommodation 

notes,  and  paid  cash  on  account  of  same  $48,000.00,  giving 

renewal  notes  for  $10,000.00. 
The  legal  fees,  interest  and  petty  expenses  paid  on  account 

of  accommodation  paper  were  $2,400.00. 

The  following  payments  also  were  made: 

Mortgage,  with  interest,  and  one  year's  interest  accrued  to  December  31, 
taxes,  bills  payable,  and  book  accounts  payable;  clerk  hire,  wages,  and 
other  business  expenses,  with  allowance  of  $100.00  per  month  to  each  of 
the  partners,  one  vear's  interest  at  6  per  cent  to  special  partner,  interest  on 
Green's  surplus  capital  ($6,325.00)  one  year  at  6  per  cent,  and  trustee's  fee  of 
$5,000.00,— in  aU,  $10,000.00. 

The  special  partner  had  an  interest  of  1/10,  and  the  general  partners 
shared  alike  in  the  residue  of  the  net  profits  and  losses. 

On  January  1,  of  the  next  year,  the  estate  reverted  to  the  firm. 

Requirements  of  the  problem: 

1.  Trustee's  realization  and  liquidation  account. 

2.  Balance  sheet  at  termination  of  trust. 

3.  Partners'  accounts. 

Solution  to  Problem  3.— There  is  illustrated  in  this  problem  the  risk  incurred 
by  exchanging  negotiable  paper  as  a  friendly  acconmiodation.  By  so  doing, 
the  business  credit  of  Messrs.  Green  and  Sharp  was  impaired  seriously  to 
the  extent  that  affairs  had  to  be  placed  in  the  hands  of  a  trustee.  The 
latter,  in  addition  to  realizing  upon  the  assets  and  liquidating  the  liabilities, 
carried  on  the  trading  activity  by  buying  and  selling  goods  for  cash,  giving 
renewal  notes,  etc. 

Since  the  opening  statement  of  condition  of  the  firm  is  given,  as  at  the 
commencement  of  the  trusteeship,  nothing  further  in  connection  therewith 
need  be  done,  as  a  first  step  in  the  solution,  except  perhaps  as  concerns  a 
revamping  of  the  partners'  Capital  accounts.  As  these  latter  concern  the 
partners  only,  the  trustee  is  not  interested  in  the  individual  amounts  thereof. 
Likewise,  since  the  trustee  has  no  title  to  the  real  estate,  the  item  has  not 
been  considered  as  having  been  turned  over  to  the  trustee. 

The  first  requirement  of  the  problem  is  to  prepare  the  trustee's  Realization 
and  Liquidation  account.  Although,  in  this  connection,  more  than  one 
form  of  statement  may  be  used,  the  one  selected  is  similar  to  that  offered 
in  the  solution  of  problem  No.  2,  above,  in  that  it  is  believed  that  this  type 
of  statement  is  subject  to  the  least  amount  of  criticism  in  comparison  with 
the  others.     This  account  is  shown  on  the  following  page. 


i 


536 


ADVANCED  ACCOUNTING 
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FIDUCIARY  STATEMENTS:  INSOLVENTS'  ESTATES      537 

The  second  requirement  of  the  problem  is  to  prepare  a  Balance  Sheet 
as  at  the  termination  of  the  trust.  This  is  given  below  in  comparative 
form.  Before  this  Balance  Sheet  can  be  prepared,  it  is  necessary  to  deter- 
mine the  cash  balance  on  Dec.  31,  19—.  Therefore,  although  not  required 
by  the  problem,  the  trustee's  Cash  account  is  shown  below  next  following 
the  Balance  Sheet. 


MESSRS.  GREEN  A  SHARP 
Comparative  Balance  Sheet 


AflBeta 
Cash, 

Merchandise, 
Bills  Receivable, 
Accommodation  Papers, 
Accounts  Receivable, 
Real  Estate, 

Total  Assets, 
Net  Decrease  in  Assets, 

Liabilities  and  Capital 
Mortgage, 

Mortgage  Interest  Accrued, 
Bills  Payable, 

Liability — ^Accommodation  Paper, 
Accounts  Payable, 
Taxes  Accrued, 

Total  Liabilities, 
Capital,  Combined, 

Total  Liabilities  and  Capital, 

Net  Decrease  in  Liabilities  and  Capital, 


as  of 
Jl.  19 — ,  and  January  1,  19 — 

December 

31,  19— 

$19,175.00 
10,000.00 

2,000.00 
25.000.00 

January 

1,  19— 

$  500.00 
20,000.00 

5,000.00 
58,000.00 

4,000.00 
25,000.00 

Increase       Decrease 
$18,675.00 

$10,000.00 

5,000.00 

58,000.00 

2,000.00 

$56.17500     $112,50000 


$10,000.00 


$10,000.00 
46,175.00 


$  5,000.00 

250.00 

1,000.00 

58,000.00 

3,550.00 

375.00 

$68,175.00 
44,325.00 


$56,175.00     $112,500.00 


$18,675.00 
56,325.00 


$75,000.00 


$75,000  00    $75,000.00 


$  5,000.00 

250.00 

1,000.00 

48,000.00 

3,550.00 

375.00 


$1,850.00 

$  1,850.00 

56,325.00 


$68,175.00 


$58,175.00 


$58,175.00     $58,17500 


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536  ADVANCED  ACCOUNTING 

TRUSTEE   FOR   MESSRS.   GREEN  &  SHARP 

Cash  Account 

January  1,  19 Decemher  31,  19— 

Balance,  January  1,  19 — ,  taken  over  $500.00 

Add: 
Receipts  During  Year: 
Cash  Sales, 
Bills  Receivable, 
Accounts  Receivable: 
Old  Accounts, 
Accommodation  Paper, 
Total  Cash  to  be  Accounted  For 

Deduct: 
Disbursements  During  Year: 

Merchandise  Purchases, 

Mortgage, 

Mortgage  Interest  (two  years 

at  5  per  cent), 

Taxes, 

Bills  Payable, 

Accounts  Payable: 

Old  Accounts, 

Accommodation  Paper, 

Legal  Fees  and  Expenses, 
Clerk  Hire  and  Wages, 
Trustee's  Commission, 

Allowances: 
S.  Green, 
J.  Sharp, 

Interest  on  Capital: 
H.  Maxwell, 

S.  Green  (surplus  capital), 
Balance,  December  31,  19 — , 

The  third  requirement  of  the  problem  is  to  present  the  partners'  Capital 
accounts.  These  are  given  below  in  tabulated  form.  Again,  although  not 
required  by  the  problem,  but  the  better  to  comprehend  the  Capital  accounts 
as  set  out,  a  Profit  and  Loss  Appropriation  Statement  is  shown,  this  being 
given  next  below  the  Capital  accounts. 


$108,000.00 
4,400.00 

$  3,600.00 
43,500.00 

$47,100.00 

$1^9,500.00 
$160,000.00 

$5,000.00 

$70,000.00 

500.00 

5,500.00 

375.00 

1,000.00 

$  3,550.00 
48,000.00 

$2,400.00 
1,620.50 
5,000.00 

51,550.00 
9,020.50 

$1,200.00 
1,200.00 

2,400.00 

$600.00 
379.50 

979.50 

$140,825  00 
$19,175  00 

FIDUCIARY  STATEMENTS:  INSOLVENTS'  ESTATES     539 


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QUESTIONS  AND  PROBLEMS 


541 


14. 

i 


QUESTIONS  AND  PROBLEMS 

Comment : 

1.  Unless  otherwise  indicated,   all  questions  and  problems  have  been 
taken  from  C.  P.  A.  examinations. 

2.  Exceptions  to  the  above  are  indicated  thus: 

a.  American  Institute  of  Accountants  (A.  I.  A.) 

b.  Other  than  C.  P.  A.  or  A.  I.  A.  (*). 

QUESTIONS   ON   CHAPTER  I 

Twenty  Questions,  Five  Problems 

1.  Define  the  following: 

a.  Bookkeeping. 

b.  Double-entry  bookkeeping. 

c.  Accounting. 

d.  Auditing. 

e.  Internal  check. 

2.  Define  the  following: 

a.  Account. 

b.  Account  stated. 

c.  Suspense  account. 

d.  Nominal  accounts. 

e.  Real  accounts. 

3.  Define  the  following: 

a.  Personal  account!. 

b.  Impersonal  accounts. 

c.  Mixed  accounts. 

d.  Major  accounts. 

e.  Subsidiary  accounts. 

4.  Define  the  following: 

a.  Current  account. 

b.  Collective  accounts. 

c.  Summary  accounts. 

d.  Specific  accounts. 

e.  Controlling  accounts. 

5.  Define  the  following: 

a.  Debit. 

b.  Credit. 

c.  Journalizing. 

d.  Trial  balance. 

e.  Ledger. 

540 


8. 


6.  Define  the  following: 

a.  Voucher.  " 

b.  Journal  voucher. 

c.  Voucher  check. 

d.  Balance  sheet. 

e.  Profit  and  Loss  statement. 

7.  Define  the  following: 

a.  Assets. 

b.  Current  assets. 

c.  Quick  assets. 

d.  Capital  assets. 

e.  Passive  assets. 
Define  the  following: 

a.  Active  assets. 

b.  Capital  liabilities. 

c.  Accrued. 

d.  Deferred  charges. 

e.  Contingent  assets  (A.  I.  A.) 
Define  the  following: 

a.  Capital. 

b.  Working  capital. 
Trading  account. 
Manufacturing  profit. 
Capital  expenditures. 

Why   should    we    favor   the    standardization    of   accounting   ter- 
minology? 

b.  What  means  would  you  suggest  as  best  adapted  to  obtain  such 

uniformity? 
e.  Give   two   examples   of   accounting   terms   that   are   ambiguous. 

(Suggest  remedies. 

11.  a.  Are  the  theory  of  accounting  and  the  theory  of  common  law  based 

in  any  respect  on  the  same  principle?     Which  is  the  most  reliable 
as  to  facts? 
b.  What  is  meant  by  theory  of  accounts? 

12.  a.  Name  three  objects  of  bookkeeping. 

b.  What  is  the  relation  of  the  accountant  to  the  bookkeeper? 

13.  a.  State  the  essential  principles  of  double-entry  bookkeeping. 

b.  Under  what  conditions  does  double-entry  bookkeeping  become  an 
exact  science? 

14.  a.  What  condition  of  oflBce  organization,  above  all  others,  leads  to 

fraud   and   defalcation   by   bookkeepers   and   cashiers?    Support 
your  opinion, 
b.  Name  the  ten  matters  of  special  importance  in  devising  any  system 
of  internal  check  in  the  handling  of  oflBce  records. 

15.  a.  What  is  the  relation  of  nominal  accounts  to  real  accounts?     How 

do  these  accounts  fulfill  the  purpose  for  which  they  are  created? 
b.  What  do  you  consider  the  most  important  account  in  a  set  of 
account  books?    Explain  fully. 


9. 


c. 

d. 

e. 

10.  a. 


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ADVANCED  ACCOUNTING 


m 


16.  a.  Which  group  of  accounts,  if  eliminated  from  double-entry  book- 

keeping, would  reduce  accounts  to  an  economic  history? 
b.  Which  class  or  classes  of  accounts  close  into  Loss  and  Gain  (Profit 
and  Loss)  account? 

17.  Prepare  a  form  of  monthly  summary  journal  entries  for  the  books  of 

original  entry. 

18.  a.  State  the  purposes  of  a  controlling  account. 

b.  Give  an  illustration  of  the  use  of  a  controUing  account. 

c.  Give  the  names  of  several  controlling  accounts. 

19.  a.  In  the  opening  of  a  ledger,  what  principle  should  be  followed  as 

to  the  order  or  arrangement  of  the  accounts?     Show  the  advantages 
of  the  different  plans, 
b.  In  what  order  should  the  accounts  be  arranged  as  they  successively 
appear  in: 

1.  A  ledger  containing  all  the  accounts  of  a  business. 

2.  A  ledger  containing  accounts  of  fixed  assets  and  fixed  liabilities, 
as  well  as  special,  nominal,  and  summary  accounts? 

20.  a.  Describe  a  method  of  keeping  accounts  so  that  an  independent 

balance  of  the  ledger,  containing  only  the  real,  nominal,  special 
and  controlling  accounts,  exclusive  of  the  individual  accounts  of 
customers  and  of  trade  creditors,  may  be  taken, 
b.  How  do  you  reconcile  a  debit  to  a  controlling  account  and  another 
debit  for  the  same  amount  to  an  individual  creditor  with  the 
fundamental  principle  of  double-entry  bookkeeping? 

PROBLEMS   ON   CHAPTER  I 


The  oflfice  of  a  firm  of  traders,  doing  business  in  San  Francisco,  was 
destroyed  by  an  earthquake.  The  books  of  account,  which  had  been  fully 
posted,  were  badly  damaged.  The  following  ledger  accounts  were  found 
to  be  legible:  Purchases,  net,  $69,000.00;  discounts,  lost,  $640.00;  Dis- 
counts, gained,  $3,450.00;  sales,  $54,000.00;  billH  receivable,  $33,000.00. 

Inquiry  at  the  bank  disclosed  a  balance  on  deposit,  $129,00(1.00.  Bills 
receivable  amounting  to  $45,000.00  had  been  discounted  at  the  bank.  An 
audit  of  the  checks  paid  by  the  bank  showed  that  $99,000.00  had  been  paid 
creditors  (including  $60,000.00  notes  payable). 

A  balance  sheet  prepared  at  the  last  closing  of  the  books  was  produced 
containing  the  following  items:  Cash,  $60,000.00;  accounts  receivable, 
$126,000.00;  loans  receivable,  $24,000.00;  real  estate,  $90,000.00;  notea  re- 
ceivable, $78,000.00;  capital,  $318,000.00;  notes  payable,  $60,000.00. 

Prepare  a  trial  balance  supplying  the  missing  accounts. 


QUESTIONS  AND  PROBLEMS 

to  open  a  set  of  double  entry  books  and  submit  a  trial  balan 
close  of  business  January  31,  1913.     Draft  the  trial  balance. 
Jan.  1. — Commenced  business  with  cash  capital, 
Deposited  in  bank, 
3. — Bought  merchandise  from  Jas.  Harrison  &  Co., 

Sold  goods  to  Wm.  Adams, 
7. — Bought  merchandise  from  W.  Smith  &  Co., 
8. — Paid  wages  in  cash. 

Sold  goods  to  H.  Allen  &  Co., 
10. — Received  check  from  Wm.  Adams  (discount,  $60), 

Bank  deposit, 
11. — Paid  Jas.  Harrison  &  Co.  by  check  (discount  $135). 
12. — Paid  by  cash,  three  months'  rent, 
13. — Bought  merchandise  from  H.  Kershaw, 
15. — Paid  wages  in  cash. 

Paid  office  exf)enses  in  cash, 
17. — Sold  goods  to  H.  Hobson, 
19. — Sold  goods  to  Wm.  Adams, 
21.— Sold  goods  to  H.  AUen  &  Co., 
22. — Paid  wages  in  cash, 

Paid  expenses  of  office  in  cash, 
25.— Paid  W.  Smith  &  Co.  by  check  (discount,  $160), 
26. — Received  check  from  H.  Allen  &  Co.  (discount,  $75), 

Bank  deposit, 
29. — Paid  wages  in  cash. 

Paid  office  expenses  in  cash. 


543 

ce  as  of  the 

$12,500.00 

11,750.00 

2,700.00 

2,400.00 

3,225.00 

40.00 

2,675.00 

2,340.00 

2,340.00 

2,565  00 

200  00 

3,700.00 

40.00 

35  00 

1,600.00 

800  00 

1,250  00 

40.00 

25.00 

3,065  00 

2,600.00 

2,600.00 

40  00 

20.00 


There  was  $175  cash  on  hand  at  the  close  of  the  month,  the  balance 
being  M.  F. 's  personal  expenditures. 


John  Doe  commenced  business  with  a  cash  capital  of  $15,000.00.  At  the 
close  of  the  fiscal  period  the  ledger  accounts  were:  accounts  receivable, 
$4,312.50;  merchandise  debit  balance,  $5,062.50;  accounts  payable,  $5,375.00; 
expense,  $900.00.     Doe's  total  loss  was  $2,775.00. 

Prepare  a  statement  of  assets  and  liabihties  and  the  profit  or  loss. 

4 

The  following  statements  comprise  the  trial  balances  of  a  business  at 
the  beginning  and  the  end  of  a  fiscal  period,  together  with  the  volume  of  the 
transactions  during  said  jjeriod: 


;  II 


M.   F.  commenced  business  January  1,   1913,  and  early  in   February 
banded  you  his  day  book  with  the  following  entries  in  it  and  requested  you 


544 


ADVANCED  ACCOUNTINO 


m 


i^^ 


Trial  Balance 

Interim 

Trial  Balance 

January 

Transactions 

December  31 

Cash, 

$1,115 

$16,583 

$16,338 

$1,360 

Mdse., 

5,050 

17,665 

26,874 

$4,159 

Debtors, 

3,110 

25,135 

24,229 

4,016 

Fixtures, 

2,800 

505 

3,305 

Creditors 

$  1,575 

18,922 

19,410 

2,063 

Loan, 

500 

1,000 

1,500 

Capital, 

10,000 

10,000 

Interest 

and 

discount 

693 

360 

333 

Rent, 

900 

900 

Insurance, 

50 

50 

Salaries, 

1,820 

1,820 

Advtg, 

900 

900 

Carting, 

1,705 

1,705 

Expense, 

1,333 

1,333 

Drawings, 

propr., 

2,000 

2,000 

$12,075 

$12,075 

$88,211 

$88,211 

$17,722 

$17,722 

a.  The  sales  book  shows  sales  posted  to  debtors   to  the  amount   of 
$25,135.00. 

b.  The  journal  shows  allowances  to  debtors  for  returns  of  merchandise 
sales,  $1,015.00,  and  claims  on  creditors  for  returns  of  merchandise  pur- 
chases, $23Q.OO;  also  application  of  debtors'  balance  to  settle  creditors' 
account  in  the  amount  of  $9,500.00,  both  accounts  being  in  the  name 
of  the  same  correspondent. 

c.  The  ledger  shows  that  the  nominal  accounts  entitled  rent,  insurance, 
and  office  salaries  contain  only  cash  charges,  while  the  nominal  accounts 
entitled  advertising,  cartage  and  expense  show  cash  charges  in  the  total 
amounts  of  $100.00,  $200.00,  and  $773.00,  respectively,  all  other  charges 
therein  being  by  invoice  duly  posted  to  creditors '  accounts. 

d.  The  merchandise  account  shows  cash  charges  of  $610.00  and  cash  credits 
of  $1,509.00,  for  cash  purchases  and  cash  sales,  respectively. 

e.  The  invoice  books  show  invoices  posted  to  creditors'  accounts  to  the 
amount  of  $19,410.00. 

Prepare  an  articulation  statement  showing  in  each  account  the  several 
elements  of  debit  and  credit  and  giving  the  title  of  the  articulation  account 
wherein  the  contra  credit  or  charge  appears. 

5 

In  taking  up  the  audit  of  the  accounts  of  a  company  for  the  year  ending 
December  31,  1912,  you  find  that  the  adjustments  made  at  the  previous 
audit  for  the  year  1911  have  not  been  taken  on  the  books,  and  that  therefore 
the  books  are  not  in  agreement  with  the  audited  accounts  as  of  that  date. 
Assuming  the  following  were  the  adjustmente  referred  to,  what,  if  any, 


QUESTIONS  AND  PROBLEMS 


545 


disposition  would  you  make  of  the  items  at  this  audit,  illustrating  your 
answer  with  draft  journal  entries,  viz. : 
To  record: 

1.  Invoices  for  merchandise  in  transit  at  December  31,  1911, 
not  on  books, 

2.  Invoices  for  merchandise  received  but  not  entered, 

3.  Reserve  for  bad  debts  (said  debts  were  written  off  in  1912), 

4.  Factory  expense  bills  of  1911  not  entered  until  January, 
1912, 

5.  Payroll  accrued  at  December  31,  1911, 

6.  Insurance  premiums  paid  in  advance  at  December  31,  1911, 

7.  Taxes  for  year  ending  December  31,  1911,  not  entered 
until  May,  1912, 

8.  Reserve  against  excess  valuation  of  inventory,  December 
31,  1911, 

9.  Depreciation  not  taken  up  on  books  prior  to  January, 
1911,  $5,000.00;  year  ending  December  31,  1911, 
$1,000.00, 

10.  To  write  off  an  unlocated  difference  in  the  accounts 
receivable  controlling  account  at  December  31,  1911, 
which,  however,  was  located  and  cancelled  in  1912, 


$  5,000.00 

10,000.00 

2,000.00 

750  00 

6,000.00 

500.00 

1,000.00 

10,000.00 

6,000.00 


1,500.00 


QUESTIONS   ON   CHAPTER  H 

Twenty  Questions,  Five  Problems 

21.  a.  Describe  the  proof  of  posting  method  used  in  testing  the  accuracy 

of  the  ledger  in  single  entry, 
b.  State  the  process  of  making  a  trial  balance  of  a  single  entry  ledger. 

22.  a.  How  may  a  set  of  books  be  changed  from  single  entry  to  double 

entry? 
b.  Explain  the  difference  between  a  balance  sheet  and  a  statement  of 
assets  and  liabilities. 

23.  a.  How  would  you  reconcile  the  pass  book  balance  with  the  cash  book 

balance? 

b.  Define:  Cash  receipts. 

c.  Define:  Disbursements. 

d.  Define:  Imprest  cash  system. 

24.  a.  Under  what  condition  would  the  receipts  and  revenues  and  the 

disbursements  and  expenses  be  alike? 
b.  Is  there  any  advantage  in  having  a  cash  account  in  the  general 
ledger,  when  the  cash  book  is  carefully  written  up  and  balanced? 
Give  reasons. 

25.  In  a  certain  business  the  cash  receipts  are  employed  in  part  to  defray 
current  expenses.  Other  disbursements  are  by  check  against  funds 
deposited.  In  arranging  books  of  account  for  such  a  business,  how 
would  you  provide  a  clear,  direct,  and  labor-saving  record  of  all  cash 
receipts  and  disbursements?    Show  the  advantages  of  this  plan. 


546 


ADVANCED  ACCOUNTING 


26.  a. 
b. 
c. 

27.  a. 


28.  a. 

b. 

c. 

29.  a. 

b. 


30.  a. 

b. 

31.  a. 

b. 


State  briefly  the  proper  manner  of  conducting  the  bills  receivable 
account. 

What  is  the  best  way  of  handling  on  the  books  the  contingent 
habihty  on  notes  receivable  that  have  !)een  discounted  at  the  bank? 
State  briefly  the  proper  manner  of  conducting  the  bills  payable 
account. 

An  ice  company  sells  coupon  books  to  its  customers;  the  coupons 
are  used  in  paying  for  ice  delivered.  These  coupon  books  are  paid 
for  m  advance  by  the  customers.  What  accounts  should  »)«  opened 
on  the  company's  books  to  record  such  transactions  and  how 
should  the  sale  of  coupons  and  dehveries  of  ice  appear  thertMU? 
State  in  the  form  of  journal  entries  transactions  for  accommodation 
paper  indorsed  by  the  firm  when  coupon  bonds  are  received  a^s 
security. 

Give  a  brief  definition  and  explanation  (using  an  illustration)  of  a 

trade  acceptance. 

State  wherein  a  trade  acceptance  differs  from 

1.  A  sight  draft. 

2.  A  promissory  note. 

Summarize  the  advantages  of  a  trade  acceptance  to 

1.  Seller. 

2.  Buyer. 

Describe  two  forms  of  sales  ledger  and  the  process  of  entering  the 
sales  m  each.  Explain  the  advantages  of  each  form. 
The  Blue  Ribbon  Jewelry  Company  takes  an  inventory  of  stock 
preparatory  to  closing  the  books  at  the  end  of  the  year.  If  called 
m  as  auditor,  how  would  you  treat  the  deduction  by  the  Blue 
Ribbon  Jeweb-y  Company  of  $15,000.00  from  the  total  of  its  inven- 
tory, as  representing  doubtful  and  uncollectible  accounts? 
Show  the  form  of  a  purchase  ledger  for  a  mercantile  concern  and 
state  whether  you  would  recommend  the  use  of  a  bound  or  looae- 
leaf  book,  giving  reason. 

Describe  at  least  four  methods,  with  forms,  for  recording  invoices 
payable  and  state  your  preference. 

Explain  fully  in  what  way,  if  at  all,  the  profit  on  sale  of  real  estate 
should  enter  into  the  trading  and  profit  and  loss  statements  of  a 
mercantile  concern.  Give  reasons  for  including  or  excluding. 
The  North  and  South  Railroad  Company  has  demolished  its  old 
wooden  station  at  a  certain  city  on  its  line  and  has  erecl^  in  its 
place  a  larger  and  more  ornate  structure  of  brick  and  stone  at  a  cost 
of  $100,000.00  in  excess  of  the  book  value  of  the  old  building,  after 
deducting  the  salvage.  Bearing  in  mind  that  this  expendit^  of 
$100,000.00  does  not  materially  increase  the  earning  capacity  nor 
decrease  the  operating  expenses  of  the  company,  what  disposition 
should  be  made  of  this  item  in  the  accounts?  State  the  general 
prmciples  that  should  govern  an  accountant  in  deaUng  with  this 
class  of  expenditure,  whether  occurring  in  a  raihroad  or  any  other 


QUESTIONS  AND  PROBLEMS 


547 


32.  a. 
b. 

c. 

33.  a. 

b. 

34.  a. 


i99.  a. 


36.  a. 
b. 
c. 


37.  a. 


b. 


38.  a. 

b. 


How  would  you  treat  cash  discounts  on  capital  expenditures,  such 
as  for  new  machinery? 

Explain  the  distinction  between  replacements  and  renewals,  giving 
also  your  idea  as  to  the  proper  method  of  recording  such  transactions 
on  the  books  of  a  manufacturing  corporation. 
Is  it  proper  to  capitahze  interest  paid  on  money  borrowed  to  provide 
for  construction?     Explain. 
Define:  Good- will. 

Give  your  ideas  as  to  the  treatment  of  good-will  in  accounts. 
Would  this  treatment  be  the  same  if  the  concern  were  losing  money? 
A  firm  of  brick  makers  under  the  term  of  their  twenty-year  lease 
agreed  that  at  the  close  of  the  term  they  would  level  the  ground,  cover 
it  with  soil  and  generally  restore  it  to  previous  conditions  for  agricul- 
tural purposes.  State  how  you  would  deal  with  this  liability  in 
preparing  a  statement  of  the  firm,  provided  you  found  that  none  of 
the  work  in  question  had  been  performed  and  no  provision  made 
therefor,  knowing  that  five  years  of  the  lease  have  expired.  ^ 
In  order  to  secure  a  particular  parcel  of  leasehold  property  on  which 
to  erect  its  operating  plant,  a  corporation  paid  a  bonus  of  $5,000.00, 
the  annual  rental  under  the  lease  being]  $50,000.00,  the  lease  run- 
ning for  a  period  of  twenty-one  years,  with  the  privilege  of  renewal 
for  a  second  period  of  twenty-one  years,  but  at  an  increased  rental  of 
$60,000.00  a  year.  How  should  such  expenses  be  treated  on  the 
company's  books? 

Submit  pro  forma  entries  covering  an  incidental  shipment  of  goods 
to  a  factory,  prepayment  of  freight,  receipt  of  advances,  receipt  of 
account  sales  with  cash  to  cover  balance  due,  and  closing  of  account. 
State  two  ways  of  treating  consignments  inward,  when  goods  are 
to  be  sold  subject  to  commission  at  the  price  at  which  they  are 
consigned.  Give  the  arguments  for  and  against  each  method  and 
your  views  thereon. 

Define:  Turnover. 

What  is  meant  by  percentage  on  turnover  and  how  is  it  ascertained? 
Explain  fully  in  what  way,  if  at  all,  overvaluation  of  opening 
inventory  should  enter  into  trading  and  profit  and  loss  statement, 
with  reason  for  inclusion  or  exclusion. 

Describe  a  means  for  the  protection  of  a  manufacturing  company 
in  the  purchase  of  necessary  materials  and  supplies  and  in  the 
payment  of  such  materials  and  supplies. 

In  handling  large  factory  payrolls,  which  do  you  consider  the  better 
practice  for  the  prevention  of  fraud,  the  taking  of  receipts  from  each 
employee  for  the  amounts  paid  or  the  establishment  of  a  good 
system  of  accounting  for  handling  payrolls.  Give  reasons  and 
explain  why  you  think  one  method  is  better  than  the  other. 
Explain  what  is  meant  by  an  arbitrage  and  cite  an  example. 
Indicate  three  ways  through  which  the  foreign  indebtedness  or 
claim  of  a  New  York  merchant  may  be  liquidated. 


548 


ADVANCED  ACCOUNTING 


39.  a. 


b. 


r    I 


In  stating  an  account  with  a  foreign  firm,  how  should  uiimatiired 
acceptances  be  treated  with  respect  to  rates  of  exchange? 
What  is  the  difference,  theoretically,  between  expenditures  by  a 
manufacturing  concern  for  fire  and  burglar  insurance,  health  and 
accident  insurance  and  watchmen?  In  which  section  of  a  profit 
and  loss  account  should  each  item  be  allocated? 
A  corporation  manufacturing  explosives  was  compelled  to  pay 
exorbitant  rates  for  a  very  limited  amount  of  insurance,  and  in 
consequence  was  obUged  to  install  an  automatic  sprinkler  system 
at  a  cost  of  $75,000.00.  This  additional  fire  protection  enabled  it  to 
secure  a  full  Une  of  insurance,  though  in  mutual  companies  and  at  a 
much  lower  rate  than  was  obtainable  prior  to  such  installation. 
At  the  end  of  the  fiscal  year  the  company  received  dividends  from 
these  mutual  insurance  companies  aggregating  $2,000.00.  To  what 
account  should  the  cost  of  the  sprinkler  system  be  charged  and  to 
what  account  should  the  dividend  be  credited?  State  your  reasons 
fully. 
40.  a.  The  president  of  a  corporation  engaged  four  salesmen  on  a  salary 
and  a  profit-sharing  basis.  To  one  he  gave  40  per  cent  of  the  profits, 
to  the  other  three,  20  per  cent  each.  The  profits  of  the  corpora- 
tion were  $102,608.18.  Show  proportion  of  profits  payable  to  each 
salesman, 
b.  State  the  process  of  closing  a  ledger  (general  ledger). 

PROBLEMS   ON   CHAPTER  U 


The  books  of  the  Butter,  Egg  and  Cheese  Company,  with  an  authorized 
and  outstanding  capital  stock  issue  of  $25,000.(X),  are  kept  by  single  entry. 

It  annually  inventories  all  its  assets  and  UabiUties  and  from  suc^h  inven- 
tory prepares  a  financial  statement.  At  December  31,  1913,  this  inventory 
is  as  follows: 


OflBce,  cash. 

Balance,  bank  A, 

Accounts  receivable, 

Ten  shares  in  competing  company, 

Plant  and  equipment, 

Merchandise  inventory, 

Prepaid  expenses, 

Overdraft,  bank  B, 

Accounts  payable. 

Mortgage  payable, 


$  1,584  00 

10,824.00 

29,521  00 

1,000  00 

64,938.00 

21,737.00 

5,081.00 

5,003  00 

19,747.00 

25,000.00 

20,000.00 


Notes  payable. 

From  a  comparison  of  the  financial  statements  at  the  beginning  and  end 
of  the  year,  you  find  that  the  item  of  "plant  and  equipment"  is  stated  in  an 
amount  less  by  $11,460.00  than  it  was  at  the  beginning  of  the  year,  plus 
additions  during  the  year. 


QUESTIONS  AND  PROBLEMS 


549 


The  financial  statement  for  the  beginning  of  the  year  showed  a  surplus  of 
$35,703.00. 

From  your  analysis  of  the  disbursements  and  unpaid  accounts  payable  at 
beginning  and  end  of  year,  you  find  total  purchases  amounting  to  $661,910.00, 
and  expenses  for  salaries,  wages,  supplies,  repairs,  etc.,  amounting  to 
$120,115.00. 

The  purchases,  however,  included  $450.00  paid  out  for  John  Smith,  an  em- 
ployee, for  which  he  has  not  reimbursed  the  company,  and  the  total  expense 
of  $120,115.00  included  $250.00  in  the  hands  of  a  buyer  as  a  working  fund. 

The  inventory  of  merchandise  at  the  beginning  of  the  year  was  $18,125.00 
and  of  prepaid  expense  was  $2,653.00. 

There  was  cancelled  on  the  customers '  ledger  during  the  year  $3,206.00  of 
uncollectible  accounts. 

There  was  paid  for  interest  and  discount  on  notes  payable,  $1,061.00.  and 
for  interest  on  mortgage,  $1,500.00. 

A  10  per  cent  dividend  was  declared  but  not  paid. 

From  the  foregoing  prepare: 

a.  Balance  sheet  as  at  December  31,  1913. 

b.  Profit  and  loss  statement,  exhibiting  net  sales,  cost  of  sales,  and  gross 
and  net  profit  for  the  year. 


Prepare  a  statement  showing  the  amount  of  the  ledger  assets  as  of  January 
1, 1910;  add  to  this  statement  the  increase  of  the  capital  stock  and  the  income 
for  the  period;  deduct  from  the  statement  the  disbursements  of  the  period, 
concluding  with  a  balance  sheet  showing  total  assets  as  of  June  30,  1910. 


The  Turnwell  Trading  Co. 

Trial 
Balance 
January 

IQIO 

Cash 

Credited 

Receipts 

to  Profit 

from 
January  1, 

and  Loss 
June  30, 

J..7XV 

1910 

1910 

Land  and  buildings. 

$30,000.00 

Horses,  wagons,  harness, 

5,000  00 

Investment  bonds. 

10,000.00 

Inventory,  merchandise. 

11,000.00 

Stable  supplies, 

150.00 

Cash, 

17,500.00 

Accounts  receivable. 

14,800.00 

$36,000.00 

Interest  on  investment. 

400.00 

$       490.00 

Increase  in  inventory,  mdse. 

500.00 

Capital  stock. 

5,000  00 

Interest  on  bank  balances, 

80.00 

80.00 

Sales, 

38,500.00 

$88,450.00 

$41,480.00 

$39,570  00 

550 


ADVANCED  ACCOUNTING 


QUESTIONS  AND  PROBLEMS 


551 


4 


H 


!! 


i 


Mortgage  payable, 
Accounts  payable, 
Interest  on  mortgage, 
Salaries  of  salesmen, 
Surjjlus, 
Capital  stock. 
Purchases, 
Freight, 
Stable  supplies, 
Advertising, 

Administrative  expenses. 
Horse,  wagon,  harness. 


Trial 

Balance 

January  1, 

1910 


$12,000.00 
9,000.00 


17,450.00 
50,000.00 


Cash 
Disburse- 
ments from 
January  1, 
to  June  30, 
1910 


I  3,500.00 

22,500.00 

150.00 

1,500.00 


425.00 

200.00 

50.00 

6,500.00 

300.00 


Charged  to 
Profit  and 

Loss 

June  30, 

1910 


$88,450.00 


$35,125.00 


$      210  00 
1,575  00 


20,000  00 

425  00 

235  00 

50  00 

6,500  00 


$28,995.00 


8 

A  cloak  manufacturing  concern,  turning  out  but  one  grade  of  cloaks 
c  aims  to  have  been  robbed  on  the  night  of  AprU  16,  and  forthwith  filefl  a 
damn  under  a  burglary  insurance  policy  it  was  carrying. 

The  proof  of  the  loss  filed  by  the  assured  (contained  two  items  vi«  • 
300  cloaks  valued  at  $12,000.00,  and  1,000  yards  of  silk  stated  to  be  worth 
♦l,uUO.OO. 

The  insurance  company  being  notified  of  the  loss,  immediately  ordered 
an  mventory  to  be  taken,  which  was  done  on  the  morning  of  the  17th 
and  disclosed  the  following:  ' 

1,250  cloaks. 

6,250  yards  of  cloth. 

2,500  yards  of  silk. 

On  the  same  day  you  were  called  in  by  the  insurance  company  to  examine 
the  books  for  the  purpose  of  proving  or  disproving  the  claim,  when  th^ 
followmg  mformation  was  obtained: 

1.  That  a  complete  inventory  had  been  taken  on  January  1,  1913,  of  the 
cloaks,  cloth,  and  silk  on  hand  at  that  date,  the  inventory  sheets  of 
which  had  subsequently  been  lost  or  destroyed.  However,  the  books 
showed  that  the  total  valuation  was  $32,675.00,  and  the  firm's  repre- 
sentatives assured  you  that  this  was  correct  and  that  the  inventory 
had  been  properly  valued  at  cost  prices  which  had  not  fluctuatixl  since. 

2.  That  the  cloth  and  silk  purchases  subsequent  to  January  1913  ha<J 
amounted  to  18,750  yards  of  cloth  and  5,000  yards  of  silk  at  average 
prices  of  50  cents  and  $1  per  yard  of  each  fabric  respectively. 

3.  That  3,000  cloaks  had  been  manufactured  during  the  same  period. 


which  had  consumed  20,000  yards  of  cloth  and  5,000  yaras  of  silk, 
while  4,500  cloaks  had  been  sold. 

You  were  further  informed  that  the  manufacturing  cost  was  as  follows: 

Material,  $5.00  per  garment 

Labor  and  other  expenses,  3.50  per  garment 

Total,  $8.50  per  garment 

Give  the  gist  of  your  report  to  j'our  client;  and  state  what,  if  any,  dif- 
ferent case  you  could  have  made  out  for  the  firm  had  you  been  employed 
by  it  instead  of  by  the  insurance  company. 


A  of  London,  in  current  account  with  B  of  New  York,  engages  an  account- 
ant to  prepare  a  statement,  to  be  mailed  to  B,  based  on  the  following  data: 

1914 
Debits: 

May  12,  .                                                         £750 

May  30,  117 

June  12,  340 

July  1,  150 

Total  debits,  £1,357 

Credits: 

June  10,  £500 

June  30,  .  300 

Total  credits,  r  800 

Balance,  £557 

Find  the  average  due  date  of  the  account  and  the  interest  at  5  per  cent  to 
July  1,  taking  365  days  to  the  year. 

10 

A  New  York  corporation  builds  a  plant  and  establishes  a  branch  in 
Liverpool,  England.  At  the  expiration  of  its  fiscal  period,  a  trial  balance 
is  forwarded  to  the  New  York  office,  as  follows: 

Plant,  £250,000 

Accounts  receivable,  187,500 

Expenses,  25,000 

Inventory  (end  of  fiscal  period),  50,000 

Remittance  account,  150,000 

Cash,                                     -  12,500 

Accounts  payable,  £  87,500 

Income  from  sales,  250  000 

New  York  office,  ^___       337^500 

£675,000     £675,000 


\'^'.  t 


552 


■ 


ADVANCED  ACCOUNTING 


A  trial  balance  of  the  New  York  books  on  the  same  date  is  as  follows: 

$2,600,000.00 


Capital  stock, 
Patents, 
Liverpool  account. 
Remittance  account. 
Expenses  at  New  York, 
Cash, 


$1,500,000.00 
1,640,250.00 

25,000.00 
64,031.25 


729,281.25 


$3.229,281  25    $3,229.281  25 

The  remittance  account  is  composed  of  four  60-day  drafts  on  Liverpool 
for  £37,500  each,  which  were  sold  in  New  York  at  $4.85^,  $4.86,  $4.86>i, 
and  $4.86^,  respectively. 

Prepare  a  balance  sheet  of  the  New  York  books  after  closing  and  a  state- 
ment of  assets  and  liabilities  of  the  Liverpool  branch  consolidated  with  the 
New  York  books.  Close  the  books  at  the  rate  of  exchange  on  the  last  day 
of  the  fiscal  period,  which  is  $4.87^^,  conversion  of  remittances  to  be  made 
at  the  average  rate  for  the  four  bills. 


QUESTIONS   ON   CHAPTER  HI 

Twenty  Questions,  Five  Problems 

41.  Analyze  and  discuss  the  following  clause  taken  from  a  certain  partner- 
ship agreement: 

"VIII.  And  it  is  further  agreed  that  the  said  party  of  the  second  part 
is  to  pay  to  the  said  party  of  the  first  part  the  sum  of  three  thousand  dollars 
($3,000.00;;  for  which  the  said  party  of  the  second  part  shall  receive  a  one- 
third  (1/3)  interest  in  said  business  of  the  said  party  of  the  first  part." 

42.  Give  a  rule  for  adjusting  partners'  accounts: 

a.  When  the  gains  or  losses  are  to  be  divided  in  proportion  to  each 
partner's  investment  and  the  time  it  remains  in  use. 

b.  When  the  proportion  of  gain  or  loss  is  fixed,  and  interest  is  calculated 
on  excess  or  deficit  of  capital. 

43.  Where  do  a  joint  stock  company  and  a  copartnership  differ  in  method 
of  profit  distribution? 

a.  Explain  fully  in  what  way,  if  at  all,  partners'  salaries  should  enter 
into  trading  and  profit  and  loss  statements,  with  reason  for  inclusion 
or  exclusion. 

b.  Explain  fully  in  what  way,  if  at  all,  partners'  drawings  should 
enter  into  trading  and  profit  and  loss  statement,  with  reason  for 
inclusion  or  exclusion. 

45.  A,  B,  and  C  are  equal  partners,  each  having  subscrbied  $5,000.00  to  the 
partnership.  A  pays  in  $3,000.00,  leaving  $2,000.00  still  due  the  partner- 
ship on  his  capital  account.  It  is  agreed  for  the  present  that  this 
$2,000.00  can  remain  unpaid,  provided  A  pays  interest  on  the  same, 
which  he  does.  Later  a  dispute  arises  as  to  how  this  interest  shall  be 
credited.  A  claims  that  it  should  be  included  with  the  earnings  of 
the  business,  the  profits  of  which  are  to  be  divided  equally  among  the 


44. 


QUESTIONS  AND  PROBLEMS 


553 


three  partners.  B  and  C  claim  that  this  interest  should  be  divided 
between  them  only,  as  they  fully  lived  up  to  their  obligations  under 
the  partnership  agreement,  while  A  had  only  partially  done  so.  To 
what  account  should  the  interest  on  the  deferred  payment  be  credited? 

36.  What  method  should  be  pursued  in  adjusting  interest  on  capital 
among  partners  whose  investments  differ  in  amount?  Give  reasons 
for  such  book  entries  as  you  would  recommend  in  the  premises. 

37.  a.  How  may  a  partnership  terminate?     Name  the  different  ways. 
b.  As  the  bookkeeper  of  a  firm  that  had  no  articles  of  copartnership, 

what  would  be  your  duty  on  learning  of  the  death  of  a  partner? 

38.  Detail  a  scheme  for  keeping  shipping  accounts  so  that  the  true  and 
exact  condition  of  each  venture  can  l:>e  shown  at  any  time.  Give 
entries  for  every  phase  of  shipping  transactions,  including  advances  to 
shipper  by  consignee,  and  state  the  object  and  effect  of  each  entry. 

49.  To  what  extent,  if  any,  should  executory  contracts  be  reflected  on  the 
general  ledger  of  an  enterprise? 

50.  A  firm  of  contractors  enters  into  contracts  for  the  erection  of  several 
buildings  constituting  an  operating  plant.  For  certain  of  the  buildings 
contracts  specify  a  fixed  price,  while  in  other  instances  the  contractor's 
comi>ensation  is  to  be  actual  cost,  plus  10  per  cent  thereon.  In  what 
manner  should  the  unfinished  contracts  be  valued  at  the  close  of  the 
fiscal  year? 

51.  At  the  date  of  a  partnership  settlement  two  contracts  are  in  hand  and 
uncompleted;  one  for  $1,200.00,  estimated  to  cost  $900.00,  is  three- 
quarters  finished  and  is  already  charged  up  to  the  customer  at  $1,200.00 
as  of  date  of  contract;  the  other  for  $2,(XX).00,  estimated  to  cost 
$1,500.00,  is  half  finished,  and  no  entry  has  been  made  therefor. 
Suggest  entries  necessary  to  adjust  these  accounts  so  that  anticipation 
of  profits  shall  not  occur. 

52.  Describe  a  system  of  accounts  suitable  for  a  firm  of  contractors  that 
does  work  on  contract  for  a  fixed  sum  and  also  on  cost  and  percentage. 

53.  A  contractor  engages  to  erect  a  building  for  $250,000.00  and  his  estimates 
indicate  a  profit  to  him  of  $25,000.(K)  in  the  transaction.  He  receives 
during  the  fiscal  year  payments  aggregating  $85,000.00  on  the  architect's 
certificates  showing  that  $100,000.00  worth  of  work  has  been  done. 
Ought  any  of  the  contemplated  profits  to  be  carried  into  the  accounts 
for  that  year  and  if  so,  how  much? 

54.  a.  What  is  understood  by  "cost"  or  "factory"  accounting? 
b.  Name  the  principal  elements  of  manufacturing  cost. 

0.  State  wherein  manufacturing  or  factory  costs  differ  from  commercial 
or  selling  costs. 

55.  Define  the  following  terms: 

a.  Storekeeper. 

b.  General  charges. 

c.  Writing  off. 

d.  Storeroom. 

e.  Stores. 

f.  Cost  of  production. 


i 


554 

g. 
h. 

56.  a. 


I(i 


b. 

c. 
57.  a. 


b 
c. 


ADVANCED  ACCOUNTING 

By-product. 
Prime  cost. 

State  generally  how  the  books  of  a  firm  doing  a  manufacturing 
business  would  differ  from  those  kept  by  a  trading  concern  as  to 
(1)  books  of  record;  (2)  ledger  accounts. 

How  would  you  classify  the  accounts  in  preparing  a  statement  of  a 
manufacturing  business? 
What  is  shown  in  the  cost  books? 

Show  the  method  and  the  advantages  in  cost  accounting  of  the 
process  of  articulating  the  general  ledger,  factory  ledger,  and  stores 
ledger  by  summary  accounts. 
.  Define:  Cost  sheet. 
Write  out  in  detaU  the  general  instructions  for  taking  the  inventory 
of  raw  materials,  work  in  process,  and  finished  goods  of  a  small 
company  manufacturing  automobiles.  Show  the  general  divisions 
that  the  inventory  requires  and  provide  against  errors  in  recording 
the  items.  ^ 

What  test  should  be  made  of  the  prime  cost  of  manufactured  goods 
to  guard  against  loss  of  raw  material  through  theft  by  employees? 
A  manufacturing  company  imports  its  raw  materials  and  purchases 
exchange  on  Europe  for  use  in  payment  therefor.  How  should  the 
exchange  account  be  treated  with  resr>ect  to  the  cost  of  production? 
In  the  preparation  of  a  manufacturing  and  trading  account  and  a 
balance  sheet,  state  on  what  basis  the  foUowing  asset  should  be 
valued:  Manufactured  product.  Give  fully  your  reason. 
Define:   Work  in  process. 

How  should  the  partly  manufactured  goods  be  valued  for  use  in  a 
balance  sheet? 

How  should  the  completely  manufactured  goods  be  valued  for  use 
m  a  balance  sheet? 

What  classes  of  salaries  and  wages  should  be  charged  directly 

against  the  cost  of  manufacture? 

Define:    Nonproductive  cost. 

A  manufacturing  corporation  carries  on  its  books  an  unappUed 

balance  of  overhead  expenses,  which  it  adds  to  the  inventory  when 

closing  the  accounts.     Is  this  correct  in  principle?     Explain. 

PROBLEMS   ON   CHAPTER  m 
11 

•■r'^'l^^?^^*  merchandise  to  the  amount  of  112,000.  X  contributed 
!J'^'^'  Y  S4,500.00.  They  afterwards  sold  Z  a  one-third  interest  for 
«b,UU0.00.  How  much  of  this  amount  should  X  and  Y  receive  respectively 
m  order  to  make  X,  Y,  and  Z  equal  partners,  assuming: 

a.  Money  paid  into  the  business  with  no  good-will. 

b.  Money  paid  into  the  business  with  good-will. 

c.  Money  not  paid  into  the  business. 


58.  a. 
b. 

c. 

59.  a. 

b. 

c. 

60.  a. 

b. 
c. 


QUESTIONS  AND  PROBLEMS 


555 


12 

The  firm  of  A  and  B  have  the  following  statements: 


Store, 

Accounts  receivable, 

Cash, 

Furniture  and  fixtures. 

Merchandise, 


S15,000.00 

12,000.00 

9,000.00 

2,800.00 

37,000.00 


Accounts  payable, 
Bills  payable, 

A,  Capital, 

B,  Capital, 


Miscellaneous  equipment,    4 ,  200 .  00 

$80,000.00 


$10,000.00 

5,000.00 

30,000.00 

35,000.00 


$80,000.00 


C  is  admitted  as  a  special  partner  with  the  following  arrangement: 
C  is  to  contribute  $30,000.00,  and  to  be  entitled  to  one-third  of  the  profit  for 
one  year.  Before  making  the  contribution,  the  following  changes  are  to  be 
ms^de  in  the  books:  Store  to  be  marked  down  5  per  cent;  allowance  for  doubtful 
accounts  to  be  created  amounting  to  2  per  cent;  merchandise  to  be  revalued 
at  $35,000.00;  furniture  and  fixtures  to  be  valued  at  $2,500.00.  At  the 
end  the  amount  of  good- will  to  be  fixed  at  three  times  the  net  profits  for  the 
year  in  excess  of  $20,000.00,  this  good-will  to  be  set  up  on  the  books,  the  cor- 
responding credit  being  to  A  and  B  equally, — A,  B,  and  C  each  to  draw 
$3,000.00  in  cash,  the  remaining  profits  to  be  carried  to  their  capital  accounts. 

During  the  year  the  following  transactions  took  place :  Merchandise  bought 
on  credit,  $240,000.00;  cash  purchases,  $25,000.00;  cash  sales,  $125,000.00; 
sales  on  credit,  $175,000.00;  accounts  payable  paid  (face,  $245,000.00,  dis- 
count 2  per  cent),  $240,100.00;  accounts  receivable  collected  (face, 
$170,000.00,  all  net  except  $50,000.00,  on  which  2  per  cent  allowed), 
$169,000.00;  buying  expenses,  paid  cash,  $1,500.00;  selling  expenses,  paid  cash 
$21,000.00;  delivery  expenses,  paid  cash,  $9,000.00;  management  expensesl 
paid  cash,  $4,500.00;  miscellaneous  expenses,  paid  cash,  $3,000.00;  interest  on 
notes  payable,  paid  cash,  $250.00;  partners  each  withdrew  $3,000.00  cash  as 
agreed. 

In  closing  the  books  for  determining  profits  and  good- will,  the  following 
were  agreed  upon:  Value  of  merchandise  on  hand,  $60,000.00;  depreciation 
on  store,  $285.00;  additional  aUowance  for  doubtful  debts,  $165.00;  furniture 
and  fixtures  written  down,  $200.00. 

Good-will  having  been  estimated  and  duly  entered,  C  then  contributes 
enough  cash  so  that  his  capital  account  equals  just  one-third  of  the  total 
capital. 

Prepare  statements  showing  how  the  accounts  are  to  be  adjusted  and  the 
balance  sheet  after  the  final  adjustment.     (A.  I.  A.) 

13 

On  April  30,  1911,  St.  John  and  Company  and  Carpel  Brothers  enter  into 
a  joint  venture  agreement.  They  each  contribute  $4,000.00  with  which  they 
pay  for  goods  that  are  shipped  on  May  1  to  John  Doe  of  San  Francisco. 
St.  John  and  Company  advance  $400.00  to  defray  freight  and  incidental 
expenses.  John  Doe,  the  consignee ,  is  allowed  10  per  cent  on  the  cost  of 
the  goods  and  is  to  sell  them  at  whatever  price  he  can  obtain  for  them. 


556 


ADVANCED  ACCOUNTING 


I 
I  ;  r 

It 


!■. 


On  June  1,  1912,  on  the  strength  of  a  report  sent  by  wire  Camel  Rrnf  h«^ 

a  check  for  $11  m^  ;ifh  "  ^  u^""""*"^  "'"^'^^  f^""  '^'^  «<"»'«■«« 
a  cfteck  for  »11,200.00  aU  the  goods  being  «,ld;  on  the  same  day  St.  John 

and  Company  settle  with  Carpel  B„,thers.  Interest  at  6  per  cnt  is  al  owed 
on  all  transactions  affecting  the  partners  in  .he  venture  (Construe  vTur 
ledger  account  m  such  a  manner  that  they  will  explain  ully  wha  Zk 
place,  and  make  a  cross  reference  possible.) 

14 

for^$S  m  ™v^J  "^"l'  '"*'?  ^^'"^  ^'  ""  *''*  P^rf^n^'^nee  "f  a  contract 
tor  JSO.OOOXX),  payable  m  two  mstalments  of  $25,000.00  each,  the  first  of  which 

ZTt^V  T^'^'Tr'  ""  ^^'^^  P"''  "'  "^^  ^o*  but  subject  t^  ,0  "r 
cent  to  be  retemed  by  the  party  of  the  secoml  part  as  security  for  the  c^ 
tmuafon  of  the  undertaking;  the  second,  together  with  the  security  reUiZ' 
as  aforesaid,  >s  to  be  paid  on  final  acceptance  of  the  completed  work 

A  haaa  capital  of  $4,000.00  available  for  payment  of  Ishnr  »l,;  k 
insufficient      Wo  th„^f„^  *  i       •  j'o.ymeiii,  oi  labor,  which  proves 

The  first  instalment  on  the  contract  falla  A„„  o„j  •       -j 
which  dat«  there  has  been  expended^ bvT:'      \      .    '  f  "^  °"  ^^^  '•  "* 

Show  by  skeleton  ledger  accounts  the  cash  payable  by  A  to  R  ,nd  r 

15 

offiTe'of'^t'x'f  Z*7  ^'  *''  "rf  ""*  "'  ""''"'  '«  «"-««"  *«  the  main 
JanuarJ  ^ig^O:^'  ^  '''"^'^^-  '''  ''^'^'y  <=<«'.  ^^ows  the  following  facts 

dislTbul!:^TiT67.*rd*''""  ""'*^"'''''  *'^'^-^»=  -««-  ""P-<1  -d 
1  1  ^^9  T^'f     ',    ;     '  '^"^  '"  P''<"=*^'  "*  Pfim«  «ost,  $62,258  61    dIus 

Sd?oot  Sir^^^'  ^^^  ^^'^^-^  ^-  -n;„t:LrE 
«7j^7^'ar''''  ^'''  Pf  chases  of  raw  material  for  the  year  an^ounted  to 

llSe!%sem7  of^T'^V''^  rn.n.,em.nt  charge^  S53, 695;  fairy 
expenses,  136,967.08.     The  cash  receipts  for  one  year's  rent  of  loft  were 


QUESTIONS  AND  PROBLEMS 


557 


$1,200.00  and  for  eleven  months '  sale  of  power,  $330.00,  the  twelfth  month 
being  unpaid. 

The  raw  materials  consumed  for  the  period  amounted  to  $64,188.33; 
management  charges  distributed,  $55,761.90;  factory  expenses  distributed 
to  cost  amounted  to  $43,033.23.  There  was  also  a  loss  on  machinery 
replacements  of  $107.50. 

The  finished  product  output  for  the  year  amounted  to  $324,583.43, 
including  all  costs.     The  transfers  to  the  main  office  were  $338,297.90. 

At  the  close  of  the  period,  December  31,  1910,  there  remained  unpaid  and 
undistributed  to  goods  in  process  the  regular  factory  payroll  for  three  days, 
amounting  to  $2,857.93,  and  also  1,500  hours  of  operatives'  overtime  at  an 
average  rate  of  45  cents  per  hour,  payable  on  a  basis  of  2>^  hours'  over- 
time as  the  equivalent  of  3^  hours'  regular  time. 

Raise  all  the  factory  ledger  accounts  affected  and  show  final  trial  balance. 


QUESTIONS   ON   CHAPTER  IV 

Twenty  Questions,  Five  Problems 

61.  a.  What  is  a  corporation,  and  how  is  it  formed? 

b.  How  does  it  differ  from  a  joint  stock  company? 

c.  What  are  the  distinguishing  characteristics  of  the  corporation  as 
compared  with  other  forms  of  business  organization?     (A.  I.  A.) 

d.  What  is  a  close  corporation? 

62.  Define  the  following: 

a.  A  sole  corporation. 

b.  A  corporation  aggregate. 

c.  An  eleemosynary  corporation. 

d.  A  public  corporation. 

e.  A  private  corporation. 

63.  a.  State  the  advantages  and  disadvantages  of  conducting  a  mercantile 

business  as  a  corporation  as  compared  with  a  partnership? 
b.  What  is  the  difference  between  capital  and  capital  stock?     Explain 
fully  (*). 

64.  a.  What  are  the  underlying  principles  of  corporation  accounting? 

b.  Name  accounts  and  use  of  each  that  are  peculiar  to  corporation 
accounting. 

65.  a.  Name  the  various  forms  of  capital  stock  and  how  created,  stating 

the  rights  and  privileges  of  each. 

c.  How  would  you  proceed  to  determine  the  book  value  of  capital 
stock? 

66.  A  corporation  has  the  following  items  in  its  balance  sheet:  accounts 
payable,  accounts  receivable,  cash,  capital  stock,  expense  accrued  not 
due,  expense  paid  in  advance,  good-will,  merchandise,  machinery, 
notes  payable,  patents,  real  estate,  reserve  for  depreciation  on  plant, 
surplus,  trade  marks,  and  treasury  stock. 

You  are  asked  to  figure  the  value  of  the  stock.     State  which  items  you 
would  take  to  get  the  gross,  and  which  items  you  would  deduct  from 


\ 


558 


ADVANCED  ACCOUNTING 


67. 


68. 


69. 


71. 


■'A 


11 


»; 


i 


the  gross  to  get  the  net  amount,  and  how  you  would  obtain  the  value 
of  each  share. 

a.  Why  is  it  necessary  that  the  authorized  amount  of  the  capital 
stock  of  a  corporation  always  should  appear  upon  the  books?     (*) 

b.  How  may  preferred  stock  be  created  after  the  organization  of  a 
corporation  ?     ( *) 

a.  In  its  prospectus  a  corporation  represents  that  it  has  an  issue  of 
"cumulative,  non-voting,  non-participating,  six  per  cent  preferred 
stock."     Give  your  interpretation  of  this  expression. 

b.  How  should  stock  placed  with  fiscal  agents  for  sale  be  treated?     (*) 

a.  State  the  entries  necessary  to  open  a  set  of  corporation  books  so 
that  the  assets  may  appear  properly  on  the  ledger. 

b.  A  corporation  is  organized  under  the  laws  of  this  state  (N.  Y.), 
with  an  authorized  capital  of  $50,000.00  divided  into  shares  having 
a  par  value  of  $100.00  each.  Six  men  agree  to  subscribe  to  ten  shares 
each.  Omitting  the  explanations  that  should  accompany  original 
entries,  draft  three  types  of  opening  entries  for  the  corporation 
and  point  out  which  one  you  would  favor.     Give  reasons. 

70.  a.  When  is  a  stock  subscription  binding?     (*) 

b.  What  is  the  liability  of  a  stockholder  as  to  stock  subscriptions? 
c-   How  should  uncalled  subscriptions  be  treated  in  the  balance  sheet? 

a.  May  a  subscriber  to  capital  stock,  part  of  the  purchase  price  only 
being  paid,  surrender  his  shares  and  cancel  his  obligation?     (*) 

b.  How  should  money  received  on  account  of  stock  subscriptions  and 
forfeited  by  nonpayment  of  instalment-s  as  they  matunt,  be  treated 
on  the  books  of  the  corporation? 

a.  What  are  organization  expenses?     (A.  I.  A.) 

b.  How  should  organization  expense  be  treated  on  the  books  of  a 
corporation? 

c.  At  what  point  do  expenses  cease  to  be  organization  ex})ense8  and 
become  operating  expenses?     (A.  I.  A.) 

73.  What  is  treasury  stock,  and  state  the  difference,  if  any,  between  that 
and  stock  authorised  but  not  issued.  At  what  price  may  either  be 
sold?     How  should  they  appear  on  the  liooks  of  account? 

74.  a.  Mention  and  explain  two  common  views  concerning  the  treatment 

of  donated  capital  stock.     (A.  I.  A.) 
b.  Prepare  journal  entry  for  retiring  treasury  stock  of  the  par  value 
of  $100.00  acquired  at  $50.00  and  the  book  value  of  $125.00. 

75.  A  company  has  acquired  at  $90.00  per  share  one  hundred  shares  of  its  own 
capital  stock,  of  the  par  value  of  $100.00  per  share.  Its  balance  sheet 
shows  treasury  stock  $9,000.00.  Is  thin  correct?  If  so,  why?  If 
not,  state  how  you  would  adjust  the  books. 

76.  a.  How  should  the  discount  and  premium  arising  from  the  sale  of  a 

company's  own  securities  held  in  its  treasury  (consider  as  capital 
stock)  be  treated  on  the  books?     Give  examples, 
b.  Is  it  proper  for  a  corporation  to  pay  a  dividend  out  of  surplus  arising 
from  the  sale  of  treasury  stock  at  a  premium?     Why? 


72. 


QUESTIONS  AND  PROBLEMS 


559 


77.  Make  the  entries  necessary  to  record  each  of  the  following  (*): 

a.  A,  B  and  C  form  a  corporation  for  $50,000.00,  authorized  capital 
stock.  A  subscribes  for  250  shares,  B  for  125  shares,  and  C  for 
125  shares.  The  subscriptions  are  made  January  2,  1920,  and  the 
cash  is  paid  in  in  full  on  February  15. 

b.  In  (a)  above.  A,  B  and  C  each  subscribed  for  125  shares. 

c.  In  (b)  above,  50  per  cent  is  to  be  paid  in  in  cash  on  allotment,  and 
the  other  50  f>er  cent  whenever  called. 

d.  In  (a)  above,  A,  B  and  C,  on  February  16,  each  donated  twenty-five 
shares  to  the  corporation  for  securing  working  capital.  This  donated 
stock  was  sold  on  February  18,  for  $80.00  a  share. 

78.  The  Jones  Manufacturing  Company  was  organized  with  a  capital 
stock  of  $200,000.00,  divided  into  2,000  shares,  par  value  $100.00  each. 
60  per  cent  of  this  stock  has  been  subscribed,  which  is  to  l^e  paid  for  in 
instalments  of  $50.00.  The  first  instalment  has  been  received  in  cash. 
Required: 

a.  Opening  entries  not  using  instalment  accounts. 

b.  Opening  entries  using  instalment  accounts  (*). 

79.  The  Syra  Oil  Company  was  organized  with  an  authorized  capital 
stock  as  follows: 

Guaranteed  stock,  $200 ,  000 .  00 

Preferred  stock,  200,000.00 

Common  stock,  600,00000 

Total,  SI. 000, OOP. 00 

The  transactions  relative  to  the  above  are  as  follows: 

a.  $150,000.00  of  the  guaranteed  stock  has  been  subscribed  and  paid 
for  in  cash. 

b.  $140,000.00  of  the  preferred  stock  has  been  subscribed,  and  $128,- 
000.00  has  been  paid  for  in  cash. 

c.  $150,000.00  of  the  common  stock  has  been  issued  as  a  bonus  to 
the  purchasers  of  the  guaranteed  stock. 

$200,000.00  of  the  common  stock  has  been  sold  and  paid  for  in  cash. 
$200,000.00  of  the  remaining  common  stock  has  been  subscribed 
for,  being  payable  in  two  instalments  of  $50.00  each,  payable  in 
60  and  90  days. 

$100,000.00  of  the  common  stock  issued  as  a  bonus  has  been 
donated  to  the  treasury. 
Required: 

1.  Entries  in  journal  form  to  cover  the  above  conditions. 

2.  Trial  balance  of  opened  ledger  (*). 

80.  A  corporation  is  organized  with  an  authorized  capital  stock  of  $30,- 
000.00  of  which  only  $20,000.00  is  sold,  and  stock  certificates  issued 
therefor.  Two  conflicting  methods  of  recording  the  capital  stock  on 
the  books  are  suggested: 

a.  Treasury  stock  to  Capital,  $30,000.00;  Cash  and  Properties  to 
Treasury  Stock,  $20,000.00. 

b.  Cash  and  Properties  to  Capital  Stock  $20,000.00.  Which  method 
is  correct  and  why? 


d 
e. 


f 


>»/' 


560 


ADVANCED  ACCOUNTING 


PROBLEMS   ON   CHAPTER  IV 


16 

The  Brookline  Coal  and  Lumber  Company  was  organized  under  the  laws 
of  the  state  of  New  York  by  John  Potter,  Harry  Berg,  and  Walter  Joseph, 
who  signed  the  certificate  of  incorporation  and  subscribed  for  ten  shares 
each  on  June  15,  192L  The  certificate  of  incorporation  was  filed  by  the 
Secretary  of  State  on  July  1,  192L  The  authorized  capital  stork  amounted 
to  $100,000.00,  divided  into  1,000  shares,  par  value  $100.00  t3ach.  The 
incorporators  paid  their  subscriptions  on  July  1.  The  organization  tax 
and  filing  fees  amounted  to  $69.20. 

During  the  subsequent  four  months,  the  following  transactions  occurred: 

July    18. — John  Dolan  purchased  100  shares  of  stock  for  cash. 
Aug.    8. — Arthur  Hoople  subscribed  for  five  shares  and  paid  25  per  cent 
on  account. 

Aug.  16. — ^John  Potter  subscribed  for  200  shares  and  paid  25  per  cent  on 
account;  Harry  Berg  subscribed  for  200  shares  and  paid  25  per  cent 
on  account;  Walter  Joseph  subscribed  for  100  shares  and  paid 
25  per  cent  on  account. 

Aug.  23. — ^I^and  for  the  yard  was  purchased  from  Andrew  Pugh  for  100 
shares  of  stock. 

Sept.  5. — $3,000.00  was  paid  Stona  &  Son,  contractors,  on  account  of 
trestle  and  of  buildings,  the  total  price  being  $25,000.00. 

Sept.    8. — The  subscribers  of  August  16,  paid  25  per  cent  on  account  of  stock 

Sept.  10. — $10,000.00  was  paid  contractors  on  account. 

Sept.  12. — The  patents  for  a  road  culvert  in  demand  by  certain  leading 

railroads  were  purchased  from  Richard  Harding  for  fifty  shares 

of  stock. 
Sept.  19. — Wagons  and  other  equipment  were  purchased  for  $10,000.00, 

$4,500.00  down  and  notes  for  the  balance. 

Sept.  28. — The  subscribers  of  August  16,  paid  their  balances  due  on  account 
of  subscriptions  as  follows: 
John  Potter,  cash  in  full. 
Harry  Berg,  cash  in  full. 
Walter  Joseph,  note  for  $5,000.00. 

Oct.      8. — Paid  balance  due  contractors. 

Oct.    14. — W^alter  Morris,  attorney,  sends  bill  for  organization  services, 

$600.00. 
Oct.    15. — Harold  Bently  subscribed  for  fifteen  shares  of  stock  and  paid 

50  per  cent  on  account. 
Oct.    20. — ^Arthur  Hoople  refused  to  make  further  payments  on  account 

of  his  subscription,  and  the  latter  was  cancelled. 
On  the  basis  of  the  above,  prepare: 

1.  Opening  journal  entry  for  general  books. 

2.  The  accounts  showing  transactions  on  general  books. 

3.  Balance  sheet,  October  31,  1921.     (*) 


QUESTIONS  AND  PROBLEMS 


17 


561 


A  corporation  is  formed  on  January  2,  1920,  with  a  nominal  capital  of 
$2,000,000.00,  shares  being  of  the  par  value  of  $100.00.  The  first  issue  is 
15,000  shares,  $25.00  per  share  being  due  upon  application;  $15.00  more 
bemg  on  allotment  on  January  15;  $20.00  due  on  February  1;  $20.00  due 
on  February  15.  14,500  shares  were  applied  for.  On  January  15,  13  000 
shares  were  allotted.  '      ' 

Present  the  entries  in  journal  form  necessary  to  record  the  above  facts  in 
logical  sequence  (*). 

18 

A  corporation  having  issued  its  capital  stock  at  par  buys  1,000  shares  at 
95.  It  later  sells  500  of  these  shares  at  98,  and  300  at  85,  and  200  at  101. 
Give  the  journal  entries  covering  these  transactions. 

How  should  the  items  appear  on  the  balance  sheet  immediately  after 
purchasing  the  stock,  and  immediately  after  each  of  the  sales?     (A.  I.  A.) 

19 

A  corporation  is  formed,  and  places  a  certain  number  of  shares  of  its 
capital  stock  (par  value  $1.00  per  share)  on  the  market,  to  be  sold  at  35 
cents  per  share,  with  the  understanding  that  there  is  to  be  no  forfeiture  of 
any  money  paid  in,  but  if  the  subscriber  l^ecomes  delinquent  for  any  instal- 
ment, a  pro  rata  number  of  shares  equal  to  the  amount  of  the  instalment 
shall  immediately  revert  to  the  company. 

**A"  subscribes  for  1,000  shares  and  pays: 
Instalment  No.  1,  12)^  cents. 
Instalment  No.  2,    5  cents. 

Then  transfers  his  interest  to  "B"  who  does  not  pay: 
Instalment  No.  3,    2}^  cents. 
Instalment  No.  4,    2}4  cents. 
Instalment  No.  5,    7}^  cents. 
But  does  pay: 
Instalment  No.  6,    5  cents. 

How  many  shares  is  "B"  entitled  to,  and  in  the  aggregate  how  much  do 
"A"  and  "B"  pay  to  the  company? 

20 

The  Zero  Manufacturing  Company  (incorporated  under  the  laws  of  New 
Jersey)  has  a  capital  of  $40,000.00,  which  is  held  as  follows-  A  $21  000  00 
B  $2,000.00,  C  $8,500.00,  and  D  $8,500.00.  On  December  31,  1920  there  is 
an  undivided  surplus  of  $34,576.00.  A  disposes  of  his  entire  interest  in  the 
concern  for  $35,000.00,  which  is  paid  to  him  by  the  company  out  of  the 
company  funds.  The  company  then  agrees  with  B  to  pay  him  for  his 
holdings  at  their  book  value,  as  determined  immediately  after  the  retire- 
ment of  A. 


k 


562 


ADVANCED  ACCOUNTING 


¥ 


\ 


I 


\i 


\ 


Draft  entries  in  journal  form,  covering  the  above  transactions,  showing 
amount  paid  to  B,  and  state  the  value  of  the  stock  remaining  in  the  names 
of  C  and  D. 

QUESTIONS   ON   CHAPTER  V 

Twenty  Questions,  Five  Problems 

81.  a.  Describe  the  steps  necessary  for  the  formation  of  a  bufiiness  cor- 

poration. State  what  is  requisite  ft)r  the  validity  of  a  contract 
by  a  corporation, 
b.  In  organizing  a  general  business  corporation,  what  must  b(^  the 
general  qualifications  of  those  executing  the  certificate  of  incor- 
poration? By  whom  is  the  certificate  of  incorporation  executed, 
to  whom  sent,  and  with  whom  filed?  How  are  the  officers  of  a 
stock  corporation  chosen?  Must  they  be  directors?  How  are 
their  powers  prescribed? 

82.  a.  Define  the  following  terms: 

1.  Good-will. 

2.  Franchise. 

3.  Common  stock. 

4.  Preferred  stock. 

5.  Watered  stock. 

b.  Differentiate  unsubscribed  stock,  unissued  stock,  issued  stock,  and 
treasury  stock. 

83.  a.  What  is  meant  by  ultra  vires  in  regard  to  the  act  of  a  corporation? 

Explain,  and  give  an  example  of  such  an  act  . 
b.  May  the  board  of  directors  of  a  cor|M>ration  delegate  its  authority 
to  agents  or  a  quorum  composed  of  less  than  a  majority  of  its 
members?     Explain.     May  a  director  vote  by  proxy  at  a  meeting 
of  a  board  of  directors? 

84.  a.  Under  what   circumstances   may   a   company  reduce    its  capital 

stock?     (♦) 
b.  Give  the  journal  entry  necessary  to  cover  the  retirement  of  $50,- 
000.00  preferred  stock  at  110,  same  btjing  in  accord  with  the  original 
sale  terms  and  conditions  (*). 

85.  Journalize  and  show  balance  sheet  allocation  covering  the  following 
transaction:  A  corporation  sells  $100,(KX).00  of  its  preferred  capital 
stock  at  115;  no  part  of  the  premium  is  available  for  dividends  (*). 

86.  Give  method  of  handling  the  following  items  on  the  books  of  a  cor- 
poration: (*) 

a.  Discount  on  stock. 

b.  Premium  on  stock. 

c.  Common  stock  issued  as  a  bonus  with  sale  of  preferred  stock. 

87.  a.  List  books  and  give  purpose  of  each,  used  by  a  corporation  but  not 

by  a  partnership, 
b.  What  knowledge  must  a  transfer  agent  possess  in  order  to  safe- 
guard his  company  in  the  transfer  (»f  its  certificat/es  of  stock? 


^ 


QUESTIONS  AND  PROBLEMS 


563 


88.  a.  Describe  how  the  stock  ledger  (shares  ledger)  of  a  corporation  is 

kept. 

b.  State  the  full  procedure  leading  up  to  the  entry  of  the  following 
transactions  in  the  shares  of  a  corporation,  the  par  value  of  which 
is  $100.00.  April  5,  1901,  James  Williamson  received  certificate 
No.  75  for  100  shares  full  paid.  May  3,  1901,  James  WiUiamson 
requests  a  transfer  to  Geo.  T.  Jenkins  of  30  of  his  100  shares. 
Outline  a  form  of  stockholders'  ledger  and  properly  enter  above 
items  therein. 

89.  A  corporation  has  four  classes  of  stock  for  each  one  of  which  a  stock 
ledger  is  carried.  A  number  of  persons  own  shares  of  more  than  one 
class  of  stock.  How  may  duplication  be  avoided  in  such  matters  as 
mailing  annual  reports,  notices  of  stockholders'  meetings,  etc.? 
Outline  in  detail  the  method  you  suggest.     (*) 

90.  A  customer  of  a  certain  corporation  owes  it  $5,000.00  and  the  company 
finds  it  impossible  to  collect  such  debt  in  due  course.  However,  this 
customer  is  a  stockholder  of  the  corporation  and,  to  cancel  such  debt, 
offers  to  pay  same  by  transferring  over  capital  stock  certificates  of  a 
total  par  value  of  $5,000.00.  The  oflFer  is  accepted.  Make  journal 
entry  upon  the  corporate  books  in  respect  of  the  above.     (*) 

91.  a.  Submit  rulings  of  transfer  journal  suitable  to  record  heavy  transfers 

of  a  listed  stock  and  all  necessary  transfer  records  to  be  used  there- 
with. Explain  fully  the  use  of  each  record  and  its  relation  to  the 
others. 

b.  What  method  would  you  adopt  to 'prove  the  outstanding  certificates 
of  stock  to  be  correct  as  represented  on  the  transfer  ledger? 

92.  A  company  whose  stock  is  widely  distributed  and  much  dealt  in, 
increases  its  capital  stock  of  $500,000.00  by  a  stock  dividend  of  100 
per  cent.  Some  years  subsequently  an  original  stockholder  brings 
suit  for  elimination  from  the  capital  stock  of  what  he  claims  is 
"  water."  How  can  the  stock  issued  as  dividend  be  eliminated  from  the 
$1,000,000.00  of  stock  outstanding? 

93.  What,  in  your  opinion,  is  the  correct  method  of  recording  on  its  books 
of  account  the  purchase  of  property  and  plant  by  a  corporation  where 
payment  is  made  in  capital  stock  of  the  purchasing  company,  the  par 
value  of  such  stock  being  greatly  in  excess  of  the  actual  value  of  the 
assets  acquired? 

94.  A  corporation  organized  under  the  laws  of  the  state  of  New  York  has 
an  authorized  capital  of  $200,000.00,  consisting  of  1,000  shares  common 
and  1,000  shares  preferred  stock,  par  value  $100.00  each.  Patents  were 
acquired  of  a  patentee  for  $50,000.00  common  and  $50,000.00  preferred 
stock.  The  patentee  donated  one-half  of  each  issue  to  the  company 
for  its  use  in  securing  working  capital.  Show  entries  necessary  to 
record  these  transactions. 

95.  A  corporation  is  organized  under  the  laws  of  the  state  of  Michigan,  with 
a  capital  stock  of  $250,000.00,  of  which  $100,000.00  is  preferred  and 
$150,000.00  is  common  stock,  shares  $100.00  each.  The  purchasers 
of  preferred  stock  at  par  are  to  receive  an  equal  amount  of  common 


i 


564 


ADVANCED  ACCOUNTING 


% 


W 


97. 


stock  free;  all  the  preferred  stock  is  subscribed  and  paid  for,  leaving 
$50,000.00  common  stock  unsubscribed.  It  is  found  that  the  remaining 
common  stock  cannot  be  sold  for  sufficient  cash  for  requirements  and 
the  holders  of  preferred  stock  donate  to  the  treasury  1.50,000.00  of 
their  common  stock.  The  common  stock  is  sold  at  50^  on  the  dollar. 
96.  A  company  is  formed  with  a  nominal  capital  of  $500,000.00,  in  50,000 
shares  of  $10.00  each.  Of  these,  40,000  are  issued  and  subscribtnl  for. 
$1.00  per  share  is  payable  on  application,  and  $2.00  per  share  on  allot- 
ment. A  call  of  $3.00  per  share  is  made  four  months  after  the  date  of 
allotment  and  a  further  call  of  $3.00  three  months  after  the  date  of  the 
first  call.  The  deposit,  with  the  amount  per  share  due  on  allotment,  is 
paid  in  full,  but  in  respect  to  the  first  call  $110,000.00  only  is  received, 
and  on  the  second  call  $95,000.00  only.  The  amounts  received  are  paid 
into  the  company's  banking  account. 
Prepare  journal  entries  to  record  the  above  transactions. 

a.  On  the  books  of  a  partnership  which  is  about  to  be  taken  over  by  a 
corporation,  is  the  following  account: 
A— Drawings,  $1,475.00.00. 
What  is  to  be  done  with  the  balance  thus  shown?     (♦) 

b.  The  Best  Store  Company  was  incorporated  for  $50,000  00  on  March 
15,  1918,  by  the  three  partners,  A,  B,  and  C.  The  change  in  organi- 
zation was  not  given  effect  upon  the  books  of  the  company.  Pro- 
prietary interest  on  January  1,  1918,  was  $75,000.00.  The  profits 
for  the  year  1918,  determined  in  January,  1919,  are  found  to  be 
$10,000.00.  Specifically  state  how  you  would  correct  this  condition 
on  the  books  of  the  Company  when  you  called  in  in  February  1919. 

a.  What  is  the  principle  underlying  capital  stock  of  no  par  value? 

b.  Outline  the  accounting  procedure  connected  with  stock  of  no  par 
value  as  to  the  following:    (*) 
1.  Stock  donated  to  treasury. 

1.  Original  issuance.  . 

2.  Stock  donated  to  treasury. 

3.  Stock  purchased  for  treasury. 

4.  Reflection  of  each  of  the  above  upon  the  balance  sheet  (*). 

c.  How  should  no  par  value  capital  stock  appear  on  the  l)alance  sheet 
of  the  owner  thereof?     (*) 

a.  A  corporation  is  formed  whose  capital  stock  has  no  par  value. 
Shares  issued,  1,000;  assets,  $8,000.00;  liabilities,  $4,000.00.  Pre- 
pare the  journal  entries  to  open  the  books. 

b.  In  setting  up  the  balance  sheet  of  a  corporation  which  has  an  issue 
of  100,000  shares  of  stock  of  no  par  value  but  a  stated  value  of 
$5.00  a  share  and  an  excess  of  assets  over  liabilities  of  $1,500,000.00, 
how  would  you  show  the  capital  on  the  balance  sheet? 

A.  B.  has  a  chance  to  buy  49  per  cent  of  the  stock  of  the  Johnson  Sales 
Company.  All  of  the  stock  is  now  owned  by  C.  J.,  and  he  will  con- 
tinue to  hold  the  balance  of  51  per  cent.  A.  B.  is  anxious  to  invest* 
as  the  business  is  very  profitable,  but  hesitates  for  fear  that  C.  J.,  who 
is  heavily  involved  in  outside  matters,  may  be  forced  to  sell  his  stock, 


98. 


99. 


100. 


QUESTIONS  AND  PROBLEMS 


565 


and  that  the  new  owners  might  try  to  "freeze  him  out."  C.  J.  has 
offered  to  protect  A.  B.  as  far  as  possible  in  this  respect.  What  would 
you  advise  A.  B.  to  do? 


PROBLEMS  ON  CHAPTER  V 
21 

The  Glenvale  Coal  Company  was  organized  in  New  York  on  July  1, 
1921,  with  an  authorized  capital  stock  of  $50,000.00,  divided  into  $25,000  00 
preferred  and  $25,000.00  common,  2,500  shares  of  each  class,  par  value  of 
each  share  $10.00.     The  certificate  of  incorporation  was  filed  July  6,  1921 

At  a  meeting  of  the  directors  held  July  7,  1921,  there  was  acquired  from 
G.  C.  Molton,  A.  B.  Kershaw,  and  C.  D.  GUbert,  at  a  valuation  of  $25,000.00, 
all  their  right,  title  and  interest  in  certain  land  held  by  them,  paralleling 
the  tracks  of  the  N.  Y.  C.  RaUroad,  upon  which  the  coal  yard  was  to  be 
situated,  same  paid  for  in  common  stock. 

In  order  to  raise  the  necessary  funds  with  which  to  commence  operations, 
these  three  persons  donated  to  the  company  49  per  cent  of  their  holdings,  or 
1,225  shares  of  common  stock.  The  stock  was  sold  from  time  to  time,  in 
blocks  of  two  shares  preferred  and  one  share  common,  for  $25.00  a  block.  In 
all,  $2,500.00  was  received  by  this  means.  Likewise,  other  stock  was  disposed 
of  as  foUows:  In  payment  of  surveying  land  Hnes,  ten  shares  of  common 
^ock  at  par;  m  payment  for  attorney's  services,  organization  taxes,  and 
filing  fees,  bill  rendered,  $400.00;  fifty  shares  of  common  stock. 

Frame  Journal  entries  opening  the  books  of  the  Glenvale  Coal  Company 
and  present  initial  balance  sheet.     (*)  * 

22 

John  Doe  owns  a  lumber  miU  business  with  property  valued  as  foUows: 
Real  estate,  $100,000.00 

Plant,  etc.,  79,000.00  ' 

^""^ber,  93,500.00 

Doe,  Smith,  Brown,  Jones  and  Robinson  organize  a  corporation  with  an 
authorized  capital  of  $1,000,000.00  divided  into  10,000  shares  of  par  value 
of  $100.00  per  share,  under  the  following  conditions: 

Doe  is  to  receive  1,000  shares  for  real  estate,  790  shares  for  plant,  and 
935  for  lumber— fully  paid  up  stock. 

Smith  subscribes  for  1,500  shares. 

Brown  subscribes  for  1,500  shares. 

Jones  subscribes  for  1,500  shares. 

Robinson  subscribes  for  775  shares. 

One  thousand  shares  are  to  be  placed  in  the  treasury  for  future  disposition, 
and  200  shares  fully  paid  up  stock  is  to  be  given  to  each  incorporator  for 
the  cash  payment  of  10  per  cent  of  par  value,  in  consideration  for  services 
i?^  u  °'*«*^^^**^^  o^  *he  company.  Each  incorporator  then  donates 
100  shares  to  the  company  for  sale  to  produce  working  capital. 

Draft  the  entries  required,  and  present  resulting  trial  balance. 


(^•.r. 


566 


'r;    .' 


,:t 


Ml 


III 


ADVANCED  ACCOUNTING 


23 


QUESTIONS  AND  PROBLEMS 


567 


The  Prosperous  Manufacturing  Company,  a  corporation,  wa«  organized 
July  1,  1914,  with  an  authorized  capital  stock  of  $215,000.00,  i)ar  value  of 
the  shares  $100.00  each,  for  the  purpose  of  manufacturing  novelties.  The 
five  incorporators  subscribed  and  paid  for  five  shares  each;  organization 
expenses  were  incurred  to  the  amount  of  $5,(KX).00,  and  were  paid  for  in 
stock;  the  balance  of  the  stock  was  disposed  of  on  the  following  (conditions: 
10  per  cent  upon  subscription,  and  three  equal  calls  for  the  balance  at  thirty, 

sixty,  and  ninety  days. 

On  July  31,  the  Prosperous  Manufacturing  Company  secured  an  option 
for  thirty  days  on  the  plant  of  A.  and  B.  for  $10,000.00,  agreeing  to  take 
over  the  assets  exclusive  of  cash  and  assuming  the  liabilities  of  the  partner- 
ship BS  at  July  31,  for  the  sum  of  $200,000.00  payable  $90,000.00  imme- 
mediately  after  taking  over  the  business  and  the  balance  in  ninety  days.  At 
the  expiration  of  the  option,  the  corporation  took  the  plant  as  agreed. 

The  following  is  a  transcript  of  A.  and  B.'s  ledger  balances  as  at  July 
31,  1914: 
land  $30,000.00 

■KM    u-  20,000.00 

Machinery,  r.  nno  00 

Furniture  and  Fixtures,  '  1!!;  ^ 

r»        Tv/r„f«,;oi  10,000.00 

RawMaterial,  ^^^^ 

Fished  Goods,  10,000.00 

^"PP^®^'  9'^  nnn  no 

Accounts  Receivable,  o '  onn  nn 

^     ,  o, JUU.UU 

M^rt'gage  on  Buildings.  ^o '^  ^ 

Reserve  for  Depreciation-Machinery,  nm  nn 

Reserve  for  Bad  Debts,  ,  I '  ^  nn 

Accounts  Payable,  )^^'^^ 

t*  51,880.00 

B, 

During  the  interval,  A.  and  B.,  with  the  consent  of  the  corporation,  had 
sold  finished  goods  for  $5,000.00,  which  was  25  per  cent  above  cost. 

The  subscriptions  to  the  stock  of  the  corporation  were  met  on  call  with 
the  exception  that  on  the  second  call  a  subscriber  for  twenty-five  shares 
notified  the  corporation  that  he  was  unable  to  complete  his  agreement  and 
he  was  released  without  further  liabUity.  The  forfeited  stock  was  sold  for 
cash  at  par. 

From  the  foregoing,  draft: 

a    Journal  entries  necessary  to  close  the  books  of  the  partnership. 

b  Journal  entries  necessary  to  open  the  books  of  the  corporation  and 
to  show  all  transactions  on  the  Prosperous  Manufacturing  Company  s 
books. 


$    300.00 
2,675.00 


c.  Balance  sheet  of  the  Prosperous  Manufacturing  Company,  September 
1,  1914. 

24 

Smith  and  Rogers  were  partners  in  an  ice  business,  sharing  profits  and 
losses  equally.  A  transcript  of  their  general  ledger  as  of  December  31, 
1921,  was  as  follows: 

Cash, 

Accounts  Receivable, 

Smith-Loan  Account,  $7  100  00 

Rogers-Loan  Account,  250  00 

Smith-Capital  Account  (excess  of  loss  over  capital) ,       1 ,  845 .  00 

Rogers-Capital  Account  (excess  of  loss  over  capital),      1 , 845 .  00 

Operation  Expenses  (earnings  deducted),  600.00 

Sundry  Expenses,  35  oo 

$7,350.00    $7,350.00 

The  two  partners  agree  to  sell  out  to  the  Eriez  Ice  Company,  chartered 
under  the  laws  of  New  York,  as  of  January  1,  1922,  in  consideration  of  forty- 
five  shares,  of  this  company's  capital  stock,  the  total  issue  being  $5,000.00, 
each  share  of  the  par  value  of  $100.00;  also,  as  part  of  this  consideration, 
$500.00  in  cash  was  to  be  paid  to  them.  The  Eriez  Ice  Company  agrees  to 
assume  the  payment  of  all  the  outstanding  liabihties,  including  the  amounts 
shown  in  the  loan  accounts  of  the  partners. 

The  partnership  books  were  used  by  the  corporation,  the  latter  going 
ahead  and  using  them  without  making  any  entries  relating  to  the  organiza- 
tion of  the  corporation  or  concerning  the  assets  acquired.  One  of  the 
incorporators,  in  payment  of  his  subscribers'  shares,  paid  in  $500.00,  which 
was  credited  to  the  loan  account  of  Smith  and  appears  in  the  total  set  out 
in  the  trial  balance  shown  above.  The  capital  accounts  and  the  expense 
accounts,  as  shown  in  the  above  transcript,  were  closed  out  subsequently 
by  the  company  to  the  profit  and  loss  account.  The  cash  payment  to  be 
made  to  Smith  and  Rogers,  as  part  of  the  purchase  price,  has  not  taken 
place. 

Required: 

1.  All  entries  necessary  to  place  the  books  of  the  corporation  in  order. 

2.  Trial  balance  of  the  adjusted  ledger.     (*) 

25 

The  Nitrite  Deposits  Company  is  incorporated  locally  to  take  over  the 
business  in  Chile  of  Messrs.  W.  E.  Greetham  and  S.  O.  Else. 

The  assets  of  the  partnership  are  valued  at  $1,000,000.00  exclusive  of 
any  good-will. 

The  company  is  incorporated  with  a  nominal  capital  of  $2,000,000.00 
in  shares  of  $100.00  each,  of  which  the  vendors  receive  15,000  shares;  the 
remainder  are  issued  to  the  public  at  par. 

The  vendors  enter  into  an  agreement  by  which  they  hand  back  2,000 
shares  as  a  gift  to  the  company  after  the  issue  to  the  public  has  been  eflfected. 


u   ..^ 


568 


ADVANCED  ACCOUNTING 


QUESTIONS  AND  PROBLEMS 


569 


1 


<        ^1 


':! 


P 


The  board  decided  to  take  these  shares  up  on  the  books  at  $50  00  each 
which  was  done.     During  the  year,  however,  the  shares  were  soYd    and 
reahzed  an  average  price  of  $90.00  a  share  ' 

QUESTIONS   ON   CHAPTER  VI 

Twenty  Questions,  Five  Problems 

101.  State  in  the  form  of  a  journal  entry  on  the  books  of  John  Brown  the 
following  transaction: 

Instalment  notes  given  by  him  on  purchase  of  real  estate;  face  of 

103.  Define: 

1.  Registered  bond. 

2.  Coupon  bond. 

3.  Mortgage  bond. 

4.  First  mortgage  bond. 

5.  CoUateral  trust  bond. 

6.  Income  bond. 

104.  Define: 

1.  Second  mortgage  6  per  cent  serial  goltl  bond. 

2.  Guaranteed  bond. 

3.  Debenture  bond. 

4.  Serial  bond. 

5.  Underlying  bond. 

105.  A  certified  pubUc  accountant,  having  performed  the  duty  at  the  close 
^several  years,  fJces  up  for  the  year  just  past  the  examination  of 
bonds-the  property  of  an  institution.  At  his  last  exammation  he 
found  coupon  bonds  in  three  classes,  -registered  as  to  principal 
registered  a^  to  principal  and  income,  and  unregistered.  In  his 
examination  of  the  books  of  account  of  the  institution,  he  found  that 
bonds  had  been  bought  during  the  year.  To  make  an  efficient  exami- 
cl^?''         "^""'^  expeditious  way,  how  might  he  treat  these  various 

106.  A  $10,000.00  5  per  cent  semi-annual  coupon  (bond)  is  bought  on   a 

1 07   t^l'^^i       f '  "^"^  ^^  ^^^''  ^^'^^^^     ^'*^^t  did  it  cost?    (A.  I.  A  ) 

107.  If  a  bond  reads  at  4  per  cent,  but  the  amount  which  will  be  received  is 

in«    TTn        *^^/^'^«^l  P^^'  ^»^at  i«  the  actual  percentage  of  cost  income? 

108.  How  ^o^d  you  record  on  the  books  of  account  the  purchase  of  securi- 
ties which  had  been  only  partially  paid  for? 

109.  The  Oak  Furniture  Company  placed  $50,000.00  of  its  undivided  earn- 
ings  in  the  hands  of  a  broker  to  invest  in  United  States  4  per  cent  bonds. 
The  bonds  were  for  $1,000.00  each  and  cost  101^,  commission  H 


110. 


Prepare  detailed  entries  to  record  properly  the  transaction  on  the 
company's  books. 

A  manufacturer  makes  extensive  investments  in  stocks  and  bonds, 
buying  and  selling  from  time  to  time  as  the  market  conditions  warrant 
and  clearing  all  such  transactions  through  his  regular  books  of  account. 
How  should  such  transactions  be  isolated  from  his  manufacturing 
operations  and  what  books  and  accounts  should  he  employ  to  record 
the  details  of  the  principal  and  income  from  such  investments? 

111.  What  is  the  advantage  of  amortization  in  regard  to  the  valuation  of 
bonds? 

112.  A  firm  purchased  ten  $1,000.00  bonds  at  97^,  due  January  1,1915, 
bearing  5  per  cent  interest,  payable  semi-annually.  What  procedure 
would  you  adopt  to  care  for  the  discount  at  maturity? 

113.  How  should  the  interest  received  on  a  bond  bought  at  a  premium  be 
treated? 

1 14.  In  case  of  bonds  purchased  at  a  premium  or  at  a  discount,  to  be  held 
until  maturity,  state  how  the  price  should  be  disposed  of  on  the  books 
at  purchase,  at  maturity,  and  at  any  intervening  time. 

115.  Sketch  the  form  of  a  bond  ledger  which  will  provide  the  purchaser  of  a 
bond  at  a  premium  with  a  perpetual  detail  record  of  each  bond  transac- 
tion. 

116.  A  corporation  has  a  number  of  investments  in  stocks  and  bonds  which 
are  listed,  and  have  a  definite  market  price  from  day  to  day.  It 
carries  them  at  their  cost  prices  in  the  ledger  and  wishes  to  retain 
these  cost  prices,  but  at  the  same  time  wishes  to  have  them  show  in 
the  balance  sheet  at  the  market  prices.  State  a  convenient  method 
of  doing  this  without  changing  the  cost  values  in  the  ledger. 

1 17.  Classify  the  Income  from  Stocks  and  Bonds  Owned  account  properly, 
according  to  the  subdivision  of  assets,  liabilities,  proprietary  interest, 
income  and  expenses  under  which  it  should  be  grouped. 

118.  Where  would  you  place  the  Appreciation  of  Securities  account  in 
the  Income  and  Profit  and  Loss  accoimt? 

119.  Explain  fully,  in  what  way,  if  at  all,  loss  on  bonds  held  and  disposed 
of  during  the  period  should  enter  into  the  trading  and  profit  and  loss 
statements  of  a  mercantile  concern.  Give  reasons  for  including  or 
excluding. 

120.  In  preparing  a  balance  sheet  of  a  corporation  how  would  you  classify 
or  deal  with  securities  representing: 

1.  An  interest  in  a  competing  company. 

2.  The  entire  ownership  of  a  plant. 

3.  An  investment  of  a  temporary  surplus  of  cash.     (A.  I.  A.) 

PROBLEMS   ON   CHAPTER  VI 

26 

In  Mr.  Jones'  private  ledger  he  keeps  accounts  with  each  investment  he 
makes,  one  of  which  is  an  investment  of  1,000  shares  (par  value  $100.00)  of 
the  A.  B.  Company  which  he  acquired  in  July,  1914,  for  $85,000.00.     After 


570 


ADVANCED  ACCOUNTING 


\\i 


this  date  and  up  to  December  31,  1918,  he  makes  further  purchases  and  sales 
of  this  stock.  A  certified  public  accountant  called  in  to  prepare  Mr. 
Jones'  income  tax  return  for  1918  finds  that  these  and  other  transactions 
have  been  written  up  in  the  following  manner,  no  effort  to  show  the  profit 
of  the  sale  of  1,000  shares  on  June  1,  1918,  having  been  attempt(^d. 


Investment  A.  B.  Company  Account 


Debits 


Credits 


July  1, 
Dec.  31, 
May  31, 
Nov.  30, 
De3.  31, 

July     1, 


Feb.  28, 
Dec.  31, 

June    1, 


$85,000.00 

15,000.00 

150,000.00 


1914. — 1,000  shares  purchased, 

1914. — Entry  to  carry  this  stock  at  par, 

1915. — Purchased  1,500  shares  at  par, 

1915. — Sold  300  shares  at  125, 

1915. — Profit  and  loss — profit  on  sale  o| 

300  shares,  7,500.00 

1916. — Stock  dividend  of  50  per  cent  on 

2,200  shares  declared  from  profits, 

accumulated  prior  to  Mar.  1, 1913,  110,000 .00 
1917.— Sold  700  shares  at  110, 
1917. — Profit  and  loss — ^profit  made  on 

sale  of  700  shares,  7 ,  000 .  00 

1918.— Sold  1,000  shares  at  125, 


$  37,500.00 


77,000.00 


125,000.00 


Rewrite  this  entire  account  to  show  how  it  should  have  been  kept  iii 
order  to  show  actual  profit  on  each  sale  and  al«o  calculate  the  actual  profit 
on  the  last  sale  of  1,000  shares.  What  is  the  book  value  of  the  total  shares 
on  hand,  December  31,  1918?     (A.  I.  A.) 

27 

a.  Determine  the  price  of  a  4^  per  cent  bond  in  the  amount  of  110,000.00, 
with  four  years  to  run,  purchased  so  as  to  net  '61^  per  cent.  The  interest  is 
payable  semi-annually.     Construct  a  schedule  of  amortization. 

b.  A  city  issues  100  5  per  cent  bonds,  par  value  $1,000.00  each,  payable  semi- 
annually. These  bonds  are  payable  in  forty  equal  annual  instalments,  yield- 
ing 4  per  cent  on  the  investment.     What  is  the  purchase  price?     (*) 

c.  Suppose  in  (b)  above,  4  per  cent  bonds  had  been  issued,  interest  payable 
semi-annually,  to  yield  5  per  cent  on  the  investment.  What  would  then  be 
the  purchase  price?     (*) 


There  were  purchased  December  31,  1919,  $100,000.00  of  Brownsville 
4  l/2s  for  $103,394.43  ex  interest. 

On  June  30,  1921,  half  of  the  bonds  were  sold  for  $52,418.55  ex  interest. 

Given  that  the  bonds  are  semi-annual  and  that  the  price  paid  in  is  such 
as  to  net  the  investor  4  per  cent,  i.e.,  2  per  cent  semi-annually,  present  an 
analysis  of  the  bond  ledger  account  as  it  would  appear  at  the  close  of 
business,  December  31,  1921. 


QUESTIONS  AND  PROBLEMS 


29 


571 


X  &  Y  are  dealers  in  bonds  and  securities,  sharing  profits  and  losses  in 
the  proportion  of  X  three-fourths  and  Y  one-fourth.  They  employ  Z  to 
sell  securities,  agreeing  to  pay  him,  in  lieu  of  a  salary,  an  amount  equal  to 
25  per  cent  of  the  net  profits  to  be  divided  between  the  partners.  During 
the  period  of  Z's  employment,  the  firm  purchased  $100,000.00  Topeka 
Traction  Company  first  mortgage  5  per  cent  bonds,  on  a  3  per  cent  basis. 
The  bonds  mature  in  one  year  and  one-half.  Interest  is  payable  semi- 
annually.    These  bonds  are  held  by  X  &  Y  until  maturity. 

Prepare  statement  of  the  Topeka  Traction  Company  bond  accounts, 
showing  cost,  amortization  and  interest.  The  total  profit  to  be  adjusted 
in  the  contract  with  Z  is  $15,000.00.     Show  the  division  of  this  profit. 


30 


The  Patriotic  Emblem  Company,  wishing  to  contribute  to  the  success 
of  the  liiberty  Loan,  agrees  to  accept  subscriptions  for  the  bonds  from  its 
employees  and  arranges  that  payments  may  be  made  either  in  cash  on 
July  2,  or  in  twelve  monthly  instalments  beginning  that  day. 

On  June  1,  cash  subscriptions  for  one  hundred  $100.00  registered  bonds 
and  two  hundred  $50.00  bearer  bonds  were  received;  also  subscriptions  for 
480  $50.00  bearer  bonds  payable  on  the  instalment  plan.  A  remittance  for 
2  per  cent  of  the  total  subscriptions  was  sent  immediately  to  Safe  &  Trust, 
Bankers,  through  whom  the  Patriotic  Emblem  Company  applied  for  the 
bonds.  Payments  to  the  bankers  for  the  balance  are  to  be  made  as  follows: 
June  28,  18  per  cent  on  instalment  subscriptions;  July  2,  balance  of  cash  sub- 
scriptions; July  30,  20  per  cent  on  instalment  subscriptions;  August  15,  30  per 
cent,  and  August  30,  30  per  cent  on  instalment  subscriptions.  The  bonds  are 
dated  June  15,  1917,  and  bear  interest  at  S}4  per  cent  per  annum  from  that 
date,  payable  semi-annually,  on  December  15,  and  June  15.  Interest  at  the 
same  rate  is  to  be  calculated  on  unpaid  instalments  from  June  15,  1917, 
both  on  the  accounts  with  the  bankers  and  with  the  subscribers. 

It  is  assumed  that  the  bonds  are  delivered  on  September  15,  1917,  to  the 
Patriotic  Emblem  Company,  who  holds  the  ones  subscribed  for  on  the 
instalment  plan,  pending  completion  of  payments.  In  October,  1917, 
certain  employees  find  it  impossible  to  continue  their  payments,  and  the 
Patriotic  Emblem  Company  agrees  to  take  over  their  subscriptions.  On 
October  31,  the  company  refunds  to  these  subscribers  all  payments  made  by 
them,  plus  interest  to  date.  The  par  value  of  the  cancelled  subscriptions  is 
$1,200.00. 

Show  ledger  accounts  necessary  to  record  the  foregoing  transactions  on 
the  general  books  of  the  Patriotic  Emblem  Company,  and  make  all  entries, 
including  interest.  The  cash  account  may  be  omitted.  Describe  method 
of  handling  accounts  with  individual  subscribers.     (*) 


h 


572 


ADVANCED  ACCOUNTING 


QUESTIONS   ON   CHAPTER  VII 

Twenty  Questions,  Five  Problems 

121.  a.  What  is  depreciation? 

b.  What  are  your  views  as  to  the  necessity  of  a  provision  for  depre- 
ciation on  fixed  or  capital  assets? 

c.  From  an  audit  of  a  public  service  corjwration  it  is  found  that  no 
depreciation  of  capital  assets  has  been  provided  by  a  charge  against 
earnings,  the  oflScials  believing  that  appreciation  of  certain  real 
estate  offsets  a  fair  amount  of  depreciation.  Is  this  a  proper 
disposal  of  the  matter?     Give  reasons.     (A.  I.  A.) 

122.  a.  Do  you  consider  it  good  accounting  practice  to  charge  oflF  deprecia- 

tion on  machinery  in  years  when  the  oi>eration  of  the  plant  results 
in  a  loss?     Give  reasons. 

b.  What  is  the  difference,  if  any,  between  depreciation,  obeolescence 
and  depletion? 

c.  A  company  manufacturing  tin  tags  charges  to  cost  of  manufacture 

(as  depreciation)  one-fourth  of  the  cost  of  the  stamping  machine, 
which  had  been  in  service  about  one  year.  The  life  of  this  machine 
was  estimated  to  be  ten  years,  but  owing  to  the  discovery  by  a 
competitor  of  a  new  method  of  stamping,  which,  while  still  imperfect, 
promises  to  revolutionize  the  business,  the  stamping  machine  now 
in  use  will  probably  be  obsolete  within  a  period  of  three  years. 
What  would  you  say  concerning  the  propriety  of  the  above  charge  to 
prime  cost? 

123.  a.  Define  the  difference  between  fluctuation  and  depreciation  in  the 

value  of  assets. 

b.  Name  three  of  the  principal  elements  that  cause  obsolescence. 

c.  Name  the  advantages  or  disadvantages  of  the  following  methods 
of  bringing  on  to  the  books  of  a  company  the  depreciation  on  its 
machinery: 

1.  Crediting  machinery  account  with  10  per  cent  of  the  balance  of  the 
account  each  year  and  charging  profit  and  loss. 

2.  Crediting  a  reserve  for  machinery  depreciation  with  10  per  cent  of 
the  balance  of  the  account  each  year  and  charging  profit  and  lose. 

How  can  you  combine  the  best  features  of  both  the  above  methods? 

124.  a.  A  public  service  corporation  that  regularly  sets  aside  from  its 

profits  a  suflBcient  amount  to  provide, for  depreciation  removes  part 
of  its  old  plant  and  replaces  it  with  a  larger  and  more  costly  one. 
The  old  plant  is  sold  for  scrap.  How  should  the  cost  of  the  new 
plant  and  the  proceeds  from  the  sale  of  the  old  plant  be  treated  in 
the  accounts  of  the  company?     Give  reasons. 

b.  How  should  expenditures  for  repairs  or  replacements  1j€  treated 
insofar  as  they  relate  to  the  question  of  depreciation? 

c.  You  are  asked  by  a  client  to  discuss  with  him  the  (juestion  of 
reserves  for  depreciation  and  depletion  of  his  various  ca])ital  assets. 
State  your  position  on  this  subject  and  enumerate  the  considerations 
you  would  advance  in  support  thereof.     Would  you,  or  would  you 


QUESTIONS  AND  PROBLEMS 


573 


not,  be  guided  by  the  rules  laid  down  by  the  internal  revenue 
authorities  in  deciding  upon  the  rates  to  be  used? 

125.  a.  What  classes  of  property,  if  any,  in  your  opinion,  are  exempt  from 

depreciation? 

b.  If  asked  to  give  advice  concerning  the  proper  rates  per  cent,  to  be 
adopted  in  providing  for  the  account  for  depreciation  on  buildings, 
machinery,  tools,  etc.,  what  could  you  recommend? 

c.  A  machine  costing  $81.00  is  estimated  to  have  a  life  of  four  years, 
with  a  residual  value  of  $16.00.  Prepare  a  statement  showing  the 
annual  charge  for  depreciation  according  to  each  of  the  following 
methods: 

1.  Straight  line. 

2.  Constant  percentage  of  diminishing  value. 

3.  Annuity  method. 

(For  convenience  in  arithmetical  calculation  assume  the  rate  of  interest 
to  be  10  per  cent.)  Discuss  the  significance  of  each  of  the  methods. 
(A.  I.  A.) 

126.  a.  To  what  extent  should  an  auditor  hold  himself  responsible  for  the 

correctness  of  depreciation? 

b.  The  book  value  of  the  plant  of  a  corporation  has  been  reduced  to 
merely  a  nominal  sum.     Under  this  condition,  state: 

1.  Whether,  periodically,  a  reservation  should  be  made  of  an  amount 
estimated  to  cover  depreciation. 
The  reasons  supporting  your  answer. 

In  the  event  of  a  difference  of  opinion  between  auditor  and  directors 
concerning  the  rate  of  depreciation  on  plant  and  machinery  as 
would  involve  an  important  alteration  in  the  proposed  rate  of 
dividend,  how  can  the  matter  be  settled  to  the  satisfaction  of  both 
parties? 

Define:   Reserve  account. 

b.  How  may  a  reserve  account  be  properly  estabUshed  and  for  what 
purpose?  What,  if  any,  contra  account  should  be  maintained? 
Under  what  circumstances  should  these  accounts  be  maintained? 
Why? 

c.  Explain  the  difference  between  real  reserves  and  nominal  reserves. 
Give  two  examples  of  each.     (A.  I.  A.) 

d.  From  the  viewpoint  of  a  balance  sheet,  what  is  the  logical  place  of: 

1.  Reserves  for  depreciation  of  physical  assets,  created  by  charges  to 
operations. 

2.  Operating  reserves. 

3.  Reserves  for  redemption  of  liabilities. 

4.  Reserves  for  contingencies. 
Give  reasons  for  your  opinion. 

a.  How  would  a  reserve  affect  the  book  value  of  capital  stock? 

b.  Explain  "contingency  reserve."  How  would  it  affect  the  book 
value  of  capital  stock? 

c.  Classify  reserve  for  income  and  excess  profits  taxes  according  to 


2. 
c. 


127. 


a. 


128. 


174 


ADVANCED  ACCOUNTING 


!i 


the  subdivision  of  assets,  liabilities,  proprietary  interest,  income 
and  expense  under  which  it  should  be  grouped. 
d.  A  corporation  owns  nearly  all  of  a  block  of  land.  The  remaining 
portion  is  purchased  subject  to  an  exmting  lease.  The  corporation 
sets  aside  out  of  surplus  an  amount  believed  to  be  sufficient  to 
extend  its  plant  over  the  entire  block  at  the  expiration  of  the  lease. 
What  ledger  title  should  be  given  to  the  amount  set  aside  and  how 
should  the  amount  be  set  up  in  the  balance  sheet?     (A.  I.  A.) 

129.  a.  An    interurban    railway    company,    wishing    to    provide    against 

possible  accidents,  adopted  the  plan  of  depositing  2  per  ami  of  their 
gross  receipts  each  month  in  a  local  savings  bank  as  a  reserve 
for  that  purpose,  charging  the  funds  so  set  aside  to  an  account 
which  they  designated  "reserve  for  a<'cidents."  The  total  fund  for 
the  year  amounted  to  $4,869.26,  out  of  which  they  paid  $950.00  for 
accidents  occurring  and  settled  during  the  twelve  months,  debiting 
such  payment  to  accident  account,  and  leaving  cash  balance  in  the 
bank  on  December  31,  of  $3,919.26. 

The  bookkeeper  endeavored  to  close  the  books  by  showing  the 
$4,869.26  as  a  charge  against  operating  for  the  year  arising  out  of 
accident  liability,  carrying  over  the  balance  in  bank  ($3,919.26) 
to  provide  for  future  accidents,  and  making  a  corresponding  credit 
to  the  "reserve  for  accidents"  account.  This  left  the  company 
with  cash  assets  of  $3,919.26  not  represented  on  the  books. 

Wherein  did  the  bookkeeper  err,  and  what  entries  should  have 
been  made  to  show  the  transaction  correctly? 
b.  You  are  employed  to  make  an  audit  by  a  stockholder  who  believes 
the  management  of  the  corporation  is  piling  up  large  secret  reserves 
with  the  view  of  buying  up  the  stock  of  the  minority  holders.  You 
are  given  free  access  to  the  books.  Explain  in  detail  what  investi- 
gations you  would  make  to  determine  the  truth  or  falsity  of  this 
belief. 

130.  a.  Define:   Reserve  fund. 

b.  Distinguish  between  a  reserve  account  and  a  reserve  fund. 

c.  If  asked  to  criticize  a  balance  sheet  prepared  by  a  client's  l)ook- 
keeper,  state  what  you  would  say  regarding  the  following  caption 
found  on  the  liability  side  of  the  balan<re  sheet:  "Reserve  fund  for 
redemption  of  bonds— $50,000.00."     Explain  fully. 

d.  Should  a  reserve  fund  be  invested  in  interest-bearing  securities? 
State  the  custom.  If  so  invested,  what  account  should  be  credited 
with  the  income? 

131.  a.  Define  the  following: 

1.  Surplus. 

2.  Appropriated  surplus. 

3.  Free  surplus. 

b.  What  do  you  understand  by  capital  surplus?  Is  it  invested 
capital? 

c.  How  would  surplus  and  appropriated  surplus  affect  the  book  value 
of  capital  stock? 


QUESTIONS  AND  PROBLEMS 


675 


132.  a.  What  items  do  you  consider  should  be  charged  or  credited  direct 

to  surplus?  Would  you  regularly  make  small  adjustments  of 
subsequently  discovered  errors  through  this  account?  Is  the 
balance  at  credit  of  surplus  ever  in  any  circumstances  a  liability, 
and  if  so,  to  whom?     (A.  I.  A.) 

b.  When  preparing  a  trading  and  profit  and  loss  account  at  the  end 
of  a  fiscal  year,  in  what  manner  would  you  treat  the  surplus  or 
deficit  brought  forward  from  prior  year? 

c.  When  is  surplus  available  for  dividends?     When  not  available? 

133.  a.  A  corporation  purchased  a  business  as  a  going  concern  on  January 

1,  1921,  with  a  right  to  the  profits  from  October  1,  1920.  Its 
capital  is:  Five  per  cent  preferred  stock,  $250,000.00;  6  per  cent 
second  preferred  stock,  $250,000.00;  common  stock,  $124,000.00. 
The  year's  profits  to  September  30,  1921,  are  found  to  have  been 
$38,320.00.  What  appropriation  of  such  profits  would  you  consider 
to  be  correct? 

b.  Can  surplus  be  created  in  any  way  other  than  through  profits 
earned  from  operations?    Explain.     (A.  I.  A.) 

c.  Distinguish  between  the  following: 

1.  Earned  surplus. 

2.  Paid-in  surplus. 

3.  Capjtal  surplus. 

4.  Appropriated  surplus.     (A.  I.  A.) 

d.  Is  the  deficiency  in  the  early  years  of  a  corporation's  activities 
(whether  an  actual  loss  or  a  deficiency  between  the  earnings  and 
the  normal  rate  of  return)  similar  to  organization  expenses?  How 
should  such  deficiencies  be  treated  in  the  accounts?  To  what  extent 
is  such  a  deficiency  similar  to  interest  paid  during  construction? 
Should  such  deficiencies  be  carried  on  the  balance  sheet?  If  so, 
should  they  be  written  off,  and  how  and  when?  May  the  deficien- 
cies representing  the  difference  between  actual  earnings  and  normal 
rate  of  return  be  capitalized,  in  the  strict  sense  of  having  capital 
stock  issued  to  a  corresponding  sum?  State  clearly  just  who  is 
affected,  and  how,  by  the  different  methods  of  treating  the  items 
mentioned  above.     (A.  I.  A.) 

Describe  the  nature  of  the  dividend  account. 

Give  the  theory  of  dividends. 

How  would  you   indicate  on  the   balance  sheet,   December  31: 

Ordinary  dividends  for  the  year,  declared  the  foUowing  January  22? 

\A.  1.  A.) 

d.  How  would  you  deal  with  the  preference  dividends  declared  July  1, 
1914,  in  auditing  a  balance  sheet  as  at  June  30,  1914? 
135.  a.  In  preparing  the  balance  sheet  of  a  corporation,  how  would  you 
treat  arrears  of  cumulative  dividends  on  preferred  stock? 

b.  When  is  it  proper  to  record  on  the  books  of  a  corporation  a  dividend 
on  cumulative  preferred  capital  stock? 

c.  How  would  you  treat  the  following  dividends  on  common  stock 


134.  a 
b 
c. 


576 


ADVANCED  ACCOUNTING 


I 


^l 


in  preparing  a  balance  sheet:  Dividends  declared  on  stock  in 
treasury:  declared  in  reduction  of  capital? 
d.  What  do  you  understand  by  the  term  "dividends  paid  out  of 
capital"?  What,  in  your  opinion,  would  constitute  such  payment, 
and  mention  any  circumstances  that  may  occur  to  you  to  justify 
such  payment? 

136.  a.  The  Hay  ward  Company  has  declared  a  dividend  of  10  per  cent  on  its 

capital  stock  of  $100,000.00,  payable  July  1,  1921;  stock  books 
close  on  June  15,  1921.  Describe  the  accounting  procedure 
incident  thereto  and  state  who  may  participate  in  the  dividends. 

b.  How  would  you  deal  with  the  unclaimed  dividends  account  in 
preparing  the  annual  accounts  of  a  company?  Comment  briefly 
on  any  points  which  would  need  special  consideration.     (A.  I.  A.) 

c.  Can  you  mention  any  distinction  between  dividends  declared  out 
of  income  and  dividends  declared  out  of  profits  realized  from  the 
increment  of  invested  values?     (A.  I.  A.) 

137.  a.  Define: 

1.  Stock  dividend. 

2.  Scrip. 

b.  In  what  respect  do  stock  dividends  differ  from  cash  dividends? 

c.  A  firm  is  incorporated  under  the  laws  of  the  state  of  New  York  to  do 
business  within  the  state,  with  an  authorized  capital  of  $100,000.00. 
Its  assets,  including  $10,000.00  for  good-will,  aggregate  $30,000.00 
When  the  books  were  closed  at  the  end  of  the  first  year,  the  net 
profits  shown  amounted  to  $8,000.00.  Are  the  directors  warranted . 
in  declaring  a  dividend?     If  so,  for  what  amount? 

138.  a.  How  would  you  handle  cumulative  dividends  in  arrears  on  the 

Balance  sheet  in  the  case  of  a  corporation  owning  the  stock  with 
respect  to  which  the  cumulative  dividends  are  in  arrears? 
b.  A  company,  of  which  you  are  the  auditor,  makes  an  issue  of  shares 
for  the  purpose  of  providing  money  to  build  a  factory  and  equip  it 
with  plant  and  machinery,  and  propose  to  pay  interest  on  such 
shares  out  of  capital,  at  the  rate  of  5  per  cent  per  annum,  during  the 
construction  of  the  factory.  Write  a  letter  to  the  board  of  directors 
presenting  them  your  views. 

139.  a.  The  X,  Y,  Z  Company  established  for  ten  years  has  a  machinery 

and  equipment  account  which  has  been  increased  from  year  to  year 
as  new  equipment  purchases  have  been  made.  It  appears  also 
that  certain  renewals  and  repairs  have  been  charged  to  this  account. 
Each  year  a  credit  has  been  made  to  the  account  for  depreciation, 
offset  by  corresponding  debit  to  profit  and  loss  account,  the  ratio 
of  depreciation  being  adequate.  The  (company  now  disposes  of  a 
part  of  its  plant  at  a  price  equal  to  what  was  paid  for  it  seven  years 
previously  and  credits  the  entire  amount  to  machinery  and  equipn 
ment  account.  What  adjustments,  if  any,  are  needed  to  correct 
the  account?  (A.  I.  A.) 
b.  The  company  also  has  several  delivery  trucks  charged  to  truck 
account  at  cost,  against  which  it  has  set  up  depreciation  at  end 


^^VB|p* 


QUESTIONS  AND  PROBLEMS 


577 


of  each  year  by  credit  to  a  separate  reserve  for  depreciation  of 

trucks,  debiting  the  amount  to  profit  and  loss  account.     A  truck 

was  purchased  January  1,  1918,  for  $4,000.00.     Depreciation  has 

been  provided  at  20  per  cent  per  annum.     On  December  31,  1919,  the 

truck  is  wrecked  by  collision.     $1,000.00    is  obtained   from    the 

insurance  company  and  $250.00    obtained   from   salvage.     What 

entries  are  needed  to  adjust  the  ledger  accounts?     (A.  I.  A.) 

140.  In  an  audit  of  the  Acme  Motor  Car  Company  you  find  the  reserve 

for  depreciation  account  and  the  surplus  account  composed  of  the 

items  as  here  enumerated: 

The  reserve  for  depreciation  account  was  opened  on  December  31, 
1915,  the  close  of  the  first  business  year,  by  debiting  the  depreciation 
accounts  of  the  various  assets  with  $265,000.00. 

The  reserve  for  depreciation  account  was  also  credited  with  $25,000.00 
on  December  31,  1916,  and  with  $20,000.00  on  December  31,  1917. 
During  1916  and  1917  the  following  items  have  been  charged  against 
this  reserve  for  depreciation  account:  assets  scrapped,  $125,000.00; 
bad  debts,  $25,000.00;  repairs,  $10,000.00;  fire  loss  on  building  and 
equipment,  $7,500.00;  organization  expense,  $65,000.00;  salesmen's 
extra  commission,  $12,000.00. 

The  surplus  account  for  1915  and  1916  has  been  closed,  the  balance 
having  been  paid  out  in  dividends. 

The  surplus  account  on  December  31,  1917,  is  found  to  consist  of  the 
following  credit  items:  reserve  for  car  guarantees,  $50,000.00;  premium 
on  stock  sold,  $50,000.00;  reserve  for  obsolescence,  $50,000.00;  bonus 
from  commercial  club,  $50,000.00;  reserve  for  income  and  excess  profits 
taxes,  1917,  $80,000.00;  operating  profits,  $750,000.00. 
You  are  requested  to  make  such  adjustments  in  the  reserve  for  depre- 
ciation account  and  surplus  account  as  are  appropriate,  and  to  show 
how  the  several  items  and  accounts  should  appear  in  the  financial 
statement. 


PROBLEMS   ON   CHAPTER  VH 


31 


A  factory  consists  of  two  blocks  of  buildings,  A  and  B.  On  the  1st  of 
January,  1917,  A  contains  engine  and  boiler  which  cost  $4,000.00,  and  ma- 
chinery costing  $13,000.00;  B  contams  machinery  costing  $7,000.00.  The 
following  are  purchases  of  machinery:  October  1,  1917,'A,  $1,000.00;  July  1, 

1918,  A,  $750.00;  B,  $1,500.00;  April  1,  1919, 'A,  $600.00;    B,  $900.00; 
October  1,  1919,  B,  $250.00. 

On  January  1,  1918,  machinery  (costing  January  1,  1917,  $1,000.00)  is 
sold  from  A  for  $625.00,  and  on  July  1,  1918,  machinery  (costing  $1,300.00 
January  1,  1917)  is  sold  from  B  for  $1,000.00. 

The  accounts  are  made  up  to  December  31,  each  year.     On  December  31, 

1919,  the  whole  premises  and  contents  are  destroyed  by  fire  and  the  fire 
insurance  company  agrees  to  pay  upon  the  following  basis:  engine  and 


'V 


11 


578 


ADVANCED  ACCOUNTING 


boiler,  cost  price,  less  depreciation  8  per  cent  i^er  annum  upon  that  sum; 
machinery  in  A,  cost,  less  depreciation  at  10  per  cent  per  annum  and  upon 
diminishing  value;  machinery  in  B,  cost,  less  depreciation  at  7^  per  cent  per 
annum  upon  diminishing  value. 

Prepare  ledger  accounts  showing  how  much  Is  recoverable  upon  tliis  basis. 

32 

A  stockholder  desires  to  know  the  book  value  of  his  stock  in  a.  corporation 
for  the  purpose  of  accepting  an  offer  from  a  purchaser  who  agrees  to  buy  his 
stock  at  the  book  value  as  shown  by  the  following  balance  sheet.  Prepare 
a  statement  showing  the  book  value  of  the  stock. 


Assets 


Cash  on  hand. 

Accounts  receivable, 

Notes  receivable. 

Inventories, 

Treasury  stock  (1,000  shares), 

Cost  of  plant. 


$  25,000.00 
100,000.00 
30,000  00 
100,000  00 
125,000  00 
800,000  00 


Liabilities 


Accounts  payable, 

Notes  payable. 

Bonds  outstanding. 

Reserve  for  shrinkage  of  inventories, 

Reserve  for  depreciation. 

Reserve  for  extinguishment  of  bonds, 

Reserve  for  additions  to  plant, 

Capital  stock  (3,000  shares). 

Reserve  for  working  capital, 

Undivided  profits. 


$1,180,000  00 

$  15,000  oO 
50,000  00 

200,000  00 
26,000  00 
50,000  00 

100,000.00 
60,000  00 

300,000  00 

200,000  00 
^19M)00^ 

$1,180,000.00 


As  on  January  1,  1905,  a  corporation  is  formed  for  the  puri>ose  of  acquiring 
and  conducting  a  cemetery,  and  starts  business  on  that  date  with  a  capital 
stock  of  $100,000.00  paid  for  in  cash.  The  company  first  purcliases  forty 
acres  of  land  within  easy  access  of  a  lai^  city,  paying  for  same  at  the  rate 
of  $1,000.00  per  acre.  It  proceeds  to  expend  considerable  sums  of  money  in 
the  purchase  and  planting  of  trees  and  shrubs,  laying  out  drives  and  path- 
ways, sodding,  building  of  glass  houses,  etc.  The  policy  of  the  company  is 
to  withhold  the  selling  of  burial  lots  until  after  January  1,  1915,  so  a«  to 
allow  the  trees  and  shrubs  to  become  more  fully  grown  and  in  the  expectation 
that  with  the  growth  of  the  city  their  proi>erty  will  become  more  valuable. 

In  the  year  1915,  the  company  commences  selling  burial  lots,  and  all 
lots  are  sold  under  a  special  provision  whereby  the  company  agrees  to 


QUESTIONS  AND  PROBLEMS 


579 


apply  50  per  cent  of  all  cash  received  on  sales  in  the  purchase  of  4  per  cent 
bonds,  until  a  total  of  $150,000.00  of  such  bonds  shall  have  been  so  purchased. 
The  agreement  further  provides  that  after  all  lots  have  been  sold  the 
company  will  wind  up  its  affairs  and  the  above  bonds,  amounting  to  $150,- 
000.00,  shall  be  given  to  the  city,  which  shall  use  the  income  of  such  bonds 
for  keeping  up  the  cemetery.  It  is  the  custom  of  the  company  not  to 
purchase  bonds  until  after  the  close  of  each  fiscal  year  and  after  the  total 
sales  of  that  year  have  been  determined. 

In  March,  1920,  the  directors  of  the  company  find  that,  while  they 
believe  the  books  to  be  in  balance,  no  proper  entries  have  been  recorded 
showing  total  cost  of  their  investment,  and  that  no  entries  have  been  made 
with  respect  to  the  fund  of  $150,000.00,  from  which  said  bonds  are  to  be 
purchased.  While  cash  dividends  have  been  declared  and  paid,  the  direc- 
tors are  in  ignorance  of  what  their  profits  actually  have  been  and  how  much 
of  the  dividends  so  received  have  been  out  of  their  profits  and  how  much  in 
the  nature  of  liquidating  dividends,  representing  a  return  of  their  original 
investment.  They,  therefore,  employ  a  certified  public  accountant  to 
determine  all  these  matters  and  to  make  the  necessary  entries  on  their  books 
and  render  report  to  them.  After  determining  the  clerical  accuracy  of 
the  books,  the  accountant  draws  off  the  two  trial  balances  given  below, 
and  from  them  prepares  the  necessary  entries  and  obtains  the  information 
required  by  the  directors. 


Trial  Balances 

Debits: 

Real  estate, 

Improvements, 

Bonds, 

Administration  expense, 

Upkeep  of  cemetery. 

Dividends  paid. 

Cash, 

Credits: 

Interest  account  representing  interest  at  4  per 

cent  on  unexi>ended  cash  during  development 

period. 

Bond  interest  account. 

Sale  of  lots. 

Capital  stock. 


Jan.  1,  1915  Jan.  1,  1920 

$  40,000  00  $  40,000  00 

45,000.00    45,000.00 

125,000.00 

46,000.00 

45,000.00 

130,000.00 

40,800.00 


20,000.00 


7,00000  

$112,000.00  $471,800.00 


$  12,000.00 


$  12,000.00 

9,800.00 

350,000.00 

100,00000 

$112,000.00  $471,800.00 


100,000.00 


An  inventory  of  their  unsold  lots  as  on  January  1,  1920,  shows  that  they 
have  ten  acres  left  unsold  of  equally  desirable  character  with  that  already 
sold.  Draw  up  entries,  prepare  profit  and  loss  statement  for  period  and 
balance  sheet  as  on  January  1,  1920,  in  same  manner  as  if  you  had  been  the 
accountant  engaged.   In  any  interest  calculation  use  4  per  cent  simple  interest. 


i 


580 


ADVANCED  ACCOUNTING 
34 


out  of  the  net  earnings  of  the  company,  a  dividend  for  the  h„lf  ?  . 

4  per  cent  on  the  preferred  stock  of  Sinnnnn  no      J,  half-year,  of 

stoek  of  tlOO  000  00      T^ere^.,  K  »100,000.00  and  3  per  cent  on  the  common 

an  undivid^Z^ce  JfZi^o^'.^'TT^"'!'''"''''''^'  '-»'->•<'- 
th.  trial  balance  is  found  to  belfoCs?  **'  '"'  """"'  °'  ''"'  '^'- 

Debits: 

Real  estate  and  buildings, 

Plant  and  machinery, 

Patents  and  good-will, 

Inventory, 

Purchases, 

Labor, 

Coal, 

Salaries — general, 

Salaries — management, 

Insurance, 

Allowances, 

Freight, 

Discount  and  interest. 

Cash  in  bank. 

Investments, 

Miscellaneous  expense, 

Book  debts. 

Preferred  stock  in  treasury, 
Repairs, 


$  32,500  00 
40,000  00 
80,000  00 
29,000  00 
«2,500  00 
X«,000  00 
6,000.00 
11,000  00 
6,000  00 
875  00 
B, 250. 00 
1,500.00 
750  00 
8,000  00 

16,500  00 
4,300.00 

42,000.00 
6,000.00 
1,000.00 


Credits: 

Preferred  stock. 

Common  stock, 

Sales, 

Notes  payable, 

Accounts  payable. 


S459, 175.00 

JIOO.OOO.OO 

100,000.00 

219,175.00 

26,000.00 

14,000.00 

S459.175  00 

shS'from  ^L"''V"''*"-**-     ^Po^'Profit  and  loss  statement  andWanc. 
rate  of  7U  ^r  o^^'  ^™*  "'^f'  '"  '^^  '""""'"*«  *"  depreciation  a    thi 

.^.t^^^^k^^L-Sdetrbad^t^'a^^^^ 

in  the  balance  sheet  for  the  dividend  as  stated.  ^ 


QUESTIONS  AND  PROBLEMS 
35 


581 


A  syndicate  having  invested  in  a  coal  property,  presents  the  following 
balance  sheet: 


Assets 


Liabilities 


141.  a. 

b. 

c. 


Acreage,  $1,500,000.00    Capital  stock,  $1,000,000.00 

Physical  equipment,  500 ,  000 .  00  Bonds— 1st  Mtg.  5s,  1 ,  000 ,  000  00 
The  syndicate  estimates  it  will  mine  and  sell  1,250,000  tons  per  year, 
and  the  life  of  the  mines  at  this  rate  will  be  twenty-five  years.  The  surface 
acreage  is  not  marketable.  It  will  require  $50,000.00  expended  annually 
in  additional  equipment.  This  physical  equipment  will  have  no  salvage 
value  at  the  expiration  of  twenty-five  years.  The  bonds  are  to  be  called 
and  paid  at  the  rate  of  $40,000.00  per  annum.  At  what  profit  per  ton  over 
direct  cost  of  mimng  must  the  coal  be  sold,  so  that  a  dividend  of  7  per  cent 
can  be  paid  yearly  on  the  stock  and  leave  at  the  close  of  business,  twenty-five 
years  hence,  sufficient  convertible  assets  to  pay  the  stockholders  in  cash  the 
par  value  of  their  stock?  Explain.  Make  a  statement  winding  up  the 
syndicate's  affairs,  assuming  the  general  correctness  of  the  estimates. 

QUESTIONS  ON  CHAPTER  Vm 

Twenty  Questions,  Five  Problems 
Do  unsold  treasury  bonds  constitute  a  liability?  Why? 
Do  unsold  bonds  of  a  railroad  company  constitute  a  liability? 
If  they  do,  under  what  accounts  would  they  appear  on  the  ledger? 
The  ledger  of  a  corporation  has  an  account  entitled:  "First  Mort- 
gage Bond  Scrip,"  showing  a  credit  balance  of  $967.54.  What 
does  this  balance  represent  and  how  would  you  treat  the  item  in 
the  balance  sheet? 

142.  Formulate  the  entry  in  respect  of  the  following:  Preferred  stock  of 
$1,000,000.00  taken  up  by  an  issue  of  first  mortgage  6  per  cent  bonds 
carrying  the  same  value,  in  accord  with  a  resolution  adopted  by  the 
stockholders  in  lawful  meeting  assembled.     (*) 

143.  A  certain  manufacturing  company  disposed  of  its  entire  $50,000,000.00 
issue  of  first  mortgage  6  pe*  cent  bonds  at  90,  the  proceeds  of  which  were 
used  to  pay  for  the  obligations  growing  out  of  the  construction  of  a 
new  plant.  Formulate  the  entries  in  respect  of  the  above,  and  indi- 
cate how  the  discount  item  should  be  dealt  with  upon  the  books  of 
account.     (*) 

144.  A  corporation  borrows  $120,000.00  for  a  period  of  ten  years  to  pay  off 
an  existing  loan  at  a  higher  rate  of  interest,  paying  therefor  in  brokerage 
and  costs  $2,750.od.     How  would  you  treat  this  item  on  the  books? 

145.  a.  Define  bond  discount  and  bond  premimn.     How  should  each  be 

treated  in  the  annual  statement  of  a  concern? 
b.  If  a  company  sells  its  own  bonds  at  a  premium,  is  the  premium 

received  a  legitimate  profit  of  the  company? 
a.  "Discounts  and  premiums  on  bonds  are  in  effect  an  addition  to 

or  a  deduction  from  the  interest  rate  paid  on  the  bonds  over  their 


146. 


582 


ADVANCED  ACCOUNTING 


QUESTIONS  AND  PROBLEMS 


583 


147.  a. 


i 


\m 


i' 


life."  (Dickinson.)  Defend  and  illustrate  this  statement  in  view 
of  your  definition  of  interest. 

b.  What  proportion  of  $15,000.00,— commission  paid  for  negotiating 
a  sale  of  bonds,  to  run  ten  years, — should  be  treated  m  an  a«sset 
at  the  end  of  the  first  year?     Give  reasons. 

How  would  you  deal  with  Bond  Issue  Expanse  account  in  preparing 
the  annual  accounts  of  a  company?  Comment  briefly  on  any 
points  which  would  need  special  consideration.     (A.  I.  A.) 

b.  The  Bristol  Manufacturing  Company  issued  and  sold  on  the  1st 
of  January,  1^— ,  to  A  and  B  (fifty  to  each  at  the  same  price),  first 
mortgage  bonds  of  $500.00  each,  bearing  interest  at  4  per  cent  per 
anmmi,  and  received  $48,000.00  in  cash.  What  records  of  the 
transactions  should  be  made,  and  in  what  books? 

148.  a.  Outline  an  entry  recording  bond  interest  due  but  not  paid  at 

time  of  making  the  entry.     What  are  the  advantages  of  such  an 
entry? 
b.  How  would  you  disclose  on  the  balance  sheet  dated  December  31, 
bond  interest  due  January  1? 

149.  Formulate  the  entries  in  respect  of  the  following: 

a.  Interest  accrued  for  eight  months  upon  an  outstanding  issue  of 
first  mortgage  6  per  cent  bonds  in  the  amount  of  $8,00(),(XX).0(). 

b.  Six  months'  interest  of  the  above  matured  upon  December  31, 
1921,  and  90  per  cent  of  the  interest  coupons  were  preeiented  for 
redemption  on  January  2,  1922. 

Indicate  how  each  of  the  above  should  be  set  out  in  a  balance  sheet 
dated  December  31,  1921.     (*) 

150.  A  company,  having  $500,000.00  of  debentures,  bearing  5  per  cent  in- 
terest, which  have  been  in  existence  for  some  years,  and  which  are  repay- 
able February  1,  1920,  arranges  to  provide  the  necessary  capital  by 
the  issue,  at  par,  of  $500,000.00,  4  per  cent  permanent  debenture  stock, 
the  interest  on  which  runs  from  January  1,  1920;  the  accounts  of 
the  company  are  made  up  to  June  30,  1920.  What,  in  your  opinion, 
is  the  proper  amount  of  debenture  interest  to  be  charged  against  the 
profits  of  the  half  year?  Give  the  reasons  upon  which  ycmr  opinion 
is  based. 

151.  a.  A  concern  has  an  authorized  issue  of  bonds  to  the  amount  of 

$100,000.00;  $40,000.00  are  sold  at  par,  $10,000.00  are  sold  at  10  per 
cent  premium,  $30,000.00  are  put  up  as  collateral  to  a  $25,000.00 
loan  at  the  bank,  and  $20,000.00  are  on  hand.  Prepare  a  balance 
sheet  showing  the  above  transactions,  supplying  the  other  needed 
accounts, 
b.  A  company  authorizes  its  oflBcers  to  borrow  for  its  account 
$100,000.00  and  give  as  security  $200,000.00  of  the  first  mortgage 
bonds  of  the  company.  How  should  this  transaction  be  treated  in 
the  balance  sheet? 

152.  a.  A  corporation  has  issued  $1,000,000.00,  5  per  cent  debenture  bonds 

redeemable   at  par,  out   of  profits,  at  the  end  of  twenty  years. 
State  what  method  should  be  adopted  to  provide  for  such  redemption 


so  that  each  year's  profit  may  bear  its  due  proportionate  burden 
of  contribution, 
b.  What  entries  would  you,  as  auditor,  deem  proper  to  record  the 
redemption  of  bonds  by  a  company  with  the  cash  deposited  with 
its  fiscal  agent,  where  such  bonds  were  cancelled? 

153.  a.  Formulate  the  journal  and  cash  book  entries  in  respect  of  the  follow- 

ing: On  July  1,  1920,  $300,000.00  of  first  mortgage  6  per  cent  bonds 
were  retired.  These  bonds  matured  on  July  1,  1925.  The  bonds 
were  retired  at  1023^,  in  accord  with  the  terms  and  conditions 
of  the  trust  deed  covering  the  property  securing  the  issue.  (*) 
b.  What  advantage,  if  any,  has  the  serial  plan  of  paying  bonds  over 
the  sinking  fund  plan? 

154.  a.  A  corpK)ration  having. issued  first  mortgage  bonds  in  the  amount  of 

$50,000.00,  sets  aside  out  of  profits  $5,000.00  each  year  and  pays 
off  at  par  bonds  to  a  similar  amount.     How  shaU  these  items  appear 
in  a  balance  sheet  at  the  end  of  five  years? 
b.  What  reason  can  you  give  for  the  creation  of  a  reserve  for  a  sinking 
fund  when  the  reserve  is  not  to  be  funded? 

155.  a.  A  sinking  fund  reserve  is  created  out  of  annual  earnings.     How  is 

the  book  value  of  the  company's  stock  affected  by  such  policy? 
Explain, 
b.  How  should  a  reserve  account  and  a  sinking  fund,  both  relating 
to  the  redemption  of  the  same  debt,  be  simultaneously  operated? 
What  purpose  is  accomplished  thereby  and  how  do  said  accounts 
respectively  app>ear  on  the  balance  sheet? 

156.  a.  Are  sinking  fund  reserve  appropriations  a  satisfactory  protection 

to  the  bondholder? 
b.  If  asked  to  criticize  a  balance  sheet  prepared  by  a  client's  book- 
keeper, state  what  you  would  say  regarding  the  following  caption 
found  on  the  liability  side  of  the  balance  sheet:   **  Reserve  Fimd  for 
Redemption  of  Bonds— $50,000.00."     Explain  fully. 

157.  a.  Should  a  reserve  fund  be  invested  in  interest-bearing  securities? 

State  the  custom.     If  so  invested,  what  account  should  be  credited 
with  the  income? 
b.  What  is  the  effect  on  a  business  of  a  sinking  fund? 

158.  Argument  has  been  strongly  urged  that  aside  from  any  question  of 
possible  mismanagement,  or  of  the  difficulty  of  making  satisfactory 
investments  to  yield  the  same  rate  as  is  paid  on  the  bonds,  a  sinking 
fund  for  bonds  is  more  expensive  than  an  arrangement  for  the  serial 
payment  of  bonds.  This  is  illustrated  by  the  case  of  $20,000.00  5  per 
cent  bonds.  If  these  are  paid  off  in  a  series,  one  each  year,  the  total 
payment  made  will  be  principal  $20,000.00,  interest  $10,500.00,  total 
$30,500.00.  The  annual  sinking  fund  to  pay  these  bonds  would  on  a 
6  per  cent  basis  amount  to  $604.85,  making  in  twenty  years  $12,097.00, 
and  the  interest  paid  on  the  bonds  would  be  $20,000.00,  total  payments 
$32,097.00.  The  apparent  excess  burden  is  accordingly  $1,597.00. 
Discuss  the  above  argument  and  show  clearly  just  what  the  figures 
mean  and  in  what  the  apparent  saving  actually  consists.     (A.  I.  A.) 


t: 


584 


ADVANCED  ACCOUNTING 


159.  You  are  auditing  the  accounts  of  a  corporation  and  you  find  the 
following  entries  in  one  month  without  sufficient  explanation- 

'D.^Ci. 1  T _ 


f  8,333.33 
100,000.00 
100,000.00 
100,000.00 
100,000.00 
100,000.00 


$  8,333  33 
100,000  00 
100,000.00 
100,000  00 
100,000  00 
100,000.00 


Profit  and  Loss, 

To — Accrued  Sinking  Fund, 
Accrued  Sinking  Fund, 

To — Reserve  for  Sinking  Fund, 
Union  Trust  Company,  Trustee, 

To — Accounts  Payable, 
Accounts  Payable, 

To — Cash, 
Sinking  Fund  No.  1, 

To — Union  Trust  Company, 
Reserve  for  Sinking  Fund, 

To — Profit  and  Loss, 

What  would  you  conceive  the  situation  to  be  and  what  recommendation 
would  you  make? 

160.  a.  From  a  theoretical  point  of  view,  are  the  contributions  tf)  a  sinking 
fund  a  proper  charge  against  profits?  Give  your  reasons, 
b.  Under  the  conditions  of  a  general  mortgage  given  by  the  Red 
Clay  Brick  Company  to  protect  its  issue  of  bonds,  provision  is 
made  for  payments  to  the  trustee  at  stated  periods,  which,  together 
with  all  accretions  from  interest  and  profits,  are  to  be  held  and 
disbursed  by  the  trustee  as  one  fund.  Should  any  distinction 
be  shown  on  the  books  of  the  brick  company  between  interest  and 
profit  so  obtained?    If  so,  give  reasons. 


PROBLEMS   ON  CHAPTER  Vm 

36 

The  Smith  and  Jones  Manufacturing  Company  issued  $200,000.00  of  first 
mortgage  fifty-year,  5  per  cent  sinking  fund  bonds  which  were  marketed  at 
981^,  1  per  cent  commission,  and  expended  the  entire  proceeds  in  the  erection 
of  theu-  plant.  The  discount  and  commission  were  charged  to  Unamorti»ed 
Debt  Discount  and  Expense  account,  to  be  subsequently  charged  to  Profit' 
and  Loss,  proportionately,  during  the  life  of  the  bonds.  Five  years  later 
the  company  was  enabled,  owing  to  a  disturbance  in  the  financial  market' 
to  purchase  $50,000.00  of  said  bonds  for  Sinking  Fund  account  at  96. 

Prepare  the  necessary  journal  entries  to  record  correctly  the  above 
transactions  of  the  company. 

37 

The  shareholders  of  a  company  with  bonds  outstanding  of  $500,000.00 
bearmg  mterest  at  5  per  cent  per  annum,  resolve  to  provide  for  paying  off  the 
same  when  they  faU  due  on  December  31,  1928,  by  investing  $50,000.00  per 
annum  out  of  the  profits  and  allowing  same  to  accumulate  with  interest- 
this  arrangement  to  commence  with  the  balance  sheet  for  the  year  ending 


QUESTIONS  AND  PROBLEMS 


585 


December  31,  1920.  Show  the  "Bond  Redemption  Account"  on  December 
31,  1924,  on  the  assumption  that  on  December  31, 1920,  and  on  the  same  day 
each  year  following,  the  $50,000.00  referred  to  was  invested  in  4  per  cent  rail- 
road bonds  at  par,  that  the  interest  thereon  to  June  30,  and  December  31,  in 
each  year  was  received  in  July  and  January  following,  and  was  allowed  to 
accumulate  in  the  bank  until  December  31,  and  June  30,  following,  respect- 
ively, when  it  was  invested  in  the  same  class  of  securities  at  the  same  price 
in  multiples  of  $1,000.00. 

3a 

Corporation  A  issues  fifty  bonds,  par  value  $50,000.00,  bearing  5  per  cent 
interest,  payable  annually.  The  bonds  are  numbered  serially,  and  are  to  be 
retired  in  consecutive  groups  of  ten  each  year.  They  are  to  be  sold  at  date 
of  issue  for  an  average  price  of  $950,00. 

a.  Submit,  in  form  of  ledger  accounts,  all  entries  required  to  handle  this 
bond  issue,  in  what  you  consider  the  most  equitable  manner,  from  date  of 
issue  to  retirement. 

b.  Corporation  B  buys  bonds  Nos.  21  to  40,  inclusive,  on  date  of  issue, 
at  $950.00  each,  and  sells  Nos.  21  to  30,  at  the  end  of  two  years,  for  $1,000.00 
each.    The  other  ten  bonds  are  retired  when  due. 

Submit  in  the  form  of  ledger  accounts,  all  necessary  entries  in  Corporation 
B's  books  for  handling  the  matter  in  what  you  consider  the  most  equitable 
manner. 


39 

At  the  beginning  of  its  fiscal  year,  a  certain  corporation  issued  bonds  for 
the  purpose  of  purchasing  machinery  with  the  proceeds.  These  bonds  were 
secured  by  a  mortgage  against  the  machinery,  which  required  that  $5,000.00 
was  to  be  set  aside  annually  out  of  net  profits  to  accumulate  a  sinking  fund 
with  which  to  retire  the  bonds. 

The  general  manager  of  the  company  was  under  a  contract  which  pro- 
vided as  follows: 

1.  He  was  to  receive  annually,  in  addition  to  his  salary,  a  5  per  cent  bonus 
from  the  profits  for  the  year. 

2.  This  bonus  was  to  be  calculated  before  the  sinking  fund  instalments 
were  charged  against  the  earnings. 

At  the  end  of  this  fiscal  year,  it  was  agreed  by  all  concerned,  upon  advice 
of  the  auditor,  that  the  machinery  mortgaged  for  the  benefit  of  the  bond- 
holders should  be  depreciated  $8,000.00  to  cover  estimated  decrease  in 
value,  and  that  a  reserve  in  such  amount  should  be  established. 

The  credit  balance  in  the  Profit  and  Loss  account  at  the  end  of  the  year, 
representing  profits  for  the  year  prior  to  adjustments  covering  bonus, 
sinking  fund  instalment,  and  depreciation  reserve,  amounted  to  $23,540.00 

Prepare  all  journal  entries  deemed  necessary  in  respect  of  the  above.     (*) 


586 


ADVANCED  ACCOUNTING 


I 


The  Virginia  Coal  Company  was  originated  on  January  1,  10l8,  began 
operations  about  January  7,  1918,  and  kept  an  ordinary  set  of  books  (by 
double  entry)  but  did  not  close  their  accounts  at  the  end  of  any  fiscal  year. 

After  an  examination  and  verification  of  all  accounts  stated  in  the  Trial 
Balance,  they  are  accepted  as  correct,  except  that  termed  "Sinking  Fund 
Payments"  ($22,500.00). 

The  mortgage  securing  bonds  to  the  amount  of  $200,000.00  contains  a 
sinking  fund  clause  providing  that  the  company  shall  deposit  semi-annually 
with  the  Sinking  Fund  Trustee  5^  per  ton  on  all  coal  mined;  such  payments 
shall  be  made  to  trustee  during  January  and  July  of  each  year  for  the  pre- 
ceding six  months'  period.  Money  so  deposited  is  to  be  applied,  as  soon  as 
practicable,  to  purchase  bonds  at  not  exceeding  115,  and  accrued  interest; 
compensation  and  expenses  of  trustee  are  also  to  be  paid  from  the  sinking 
fund.  Bonds,  when  redeemed,  cannot  be  cancelled,  but  are  to  be  held  by 
trustee  who  shall  collect  the  semi-annual  interest  thereon  and  apply  to  the 
same  purposes  as  the  5^  per  ton  payments. 

Bonds  are  dated  January  1,  1918,  run  for  20  years  and  bear  interest  at 
6%  per  annum,  payable  January  1  and  July  1  of  each  year. 

Payments  to  sinking  fund  trustees  (the  General  Trust  Company)  have 
been  as  follows: 

July  27,  1918  Payment  for  6  months  ended  6/30/18,  5i  per  ton 

on  120,000  tons,  $  6,000.00 

Jan.  24,  1919  Payment  for  6  months  ended  12/31/18,  5ff  per 

ton  on  150,000  tons,  7,500.(X) 

July  28,  1919  Payment  for  6  months  ended  6/30/19,  5^  per 

ton  on  180,000  tons,  •  9,000  00 

$22,500~00 

On  January  30,  1920,  the  company  paid  to  the  General  Trust  Company 
(S.  F.  Trustee)  $5,500.00  for  sinking  fund  payment  for  the  6  months  ended 
December  31,  1919,  being  5^  per  ton  on  110,000  tons. 

The  General  Trust  Company  submitted  statements  of  receipts  and  dis- 
bursements for  account  of  the  Sinking  Fund  to  date  (January  31,  1920) 
as  follows: 

Cash  Received  to  December  31,  1919'j 

July  27,  1918  S.  F.  deposit  for  six  months  ended  6/30/18,  120,000 

*onsat5ff,  I  6,000  00 

Jan.  5,  1919  January  1919,  coupons  on  five  bonds,  150.00 

Jan.  24,  1919  S.  F.  deposit  for  six  months  ended  12/31/19, 

150,000  tons  at  5ff,  7,500  00 

July  3,  1919  July  1919,  coupons  on  twelve  bonds,  360.00 

July  28,   1919  S.  F.  deposit  for  six  months  ended  6/30/19, 

180,000  tons  at  5fi,  9,000  00 

$28,010^ 


QUESTIONS  AND  PROBLEMS 


587 


Cash  Disbursements  to  December  31,  1919 

Aug.  16,  1918. — Bonds  redeemed — 5,000  at  110, 
Commission  at  ^  per  cent, 
Accrued  interest, 


Feb.  15,  1919.— Bonds  redeemed: 

4,000  at  108, 
2,000  at  110, 
1,000  at  112, 

Commission, 
Accrued  interest, 
Aug.  12,  1919. — Bonds  redeemed: 

9,000  at  90, 
1,0(X)  at  par, 

Commission, 
Accrued  interest, 

Dec.  31,  1919. — Compensation  of  trustee, 
Advertising, 


$5,500.00 
12.50 
37.50 

$5,550.00 


$4,320.00 
2,200.00 
1,120.00     $7,640.00 

17.50 
52  50 

$8,100.00 
1,00000     $9,100.00 

250  00 
70.00 


$7,710.00 


$ 


100.00 
50  00 


9,420.00 


150  00 


$22,830.00 
$       180.00 


Cash  balance  in  hands  of  trustee,  December  31,  1919, 

Received  in  January,  1920,  viz: 

S.    F.    deposit   for   6   months   ended    12/31/19, 

110,000  tons  at  5^,  $5,500.00 

Coupons  on  22  bonds  in  S.  F.,  ^         660.00 

Interest  allowed  on  balance  to  12/31/20,  '  1(X)  00       $6  260  00 

$6,44000 

Prepare  entries  to  state  properly  on  the  books  of  the  Virginia  Coal 
Company  all  sinking  fund  transactions. 

QUESTIONS   ON   CHAPTER  IX 

Twenty  Questions,  Five  Problems 

161.  a.  Define  a  trial  balance. 

b.  Describe  the  process  of  taking  a  trial  balance. 

c.  What  is  the  function  of  a  trial  balance? 

d.  Do  you  consider  the  use  of  a  trial  balance  necessary? 

162.  a.  In  case  of  a  discrepancy  in  a  trial  balance,  how  may  the  accountant 

ascertain  which  side  is  erroneous? 

b.  When  accounts  are  in  equilibrium,  what  may  be  said  as  to  their 
correctness? 

c.  What  deductions  may  be  safely  drawn  from  a  trial  balance  repre- 
sentmg  intrinsic  values  and  true  economic  history  of  the  transac- 
tions of  a  given  period? 

163.  a.  How  should  the  foUowing  inventories  be  valued  for  the  purposes  of  a 

balance  sheet  at  any  given  date* 
1.  Finished  products. 


588 


ADVANCED  ACCOUNTING 


2.  Goods  in  process  of  manufacture. 

3.  Raw  materials. 

b.  On  the  balance  sheet  prepared  by  you  from  the  books  of  a  client, 
state  which  items  are  matters  of  fact  and  which  matters  of  opinion. 

164.  a.  State  the  difference  between: 

1.  Receipts  and  revenue. 

2.  Expense  and  disbursements. 

b.  Define  each  of  the  following  terms: 

1.  Capital  expenditure. 

2.  Repair  and  upkeep  expenditure. 

3.  Deferred  charges. 

4.  Capital  receipts. 

165.  Indicate  how  you  would  distribute  the  foUowing  as  between  capital 
and  revenue  accounts: 

a.  Extensive  repairs  made  to  the  equipment  of  a  power  house  in  the 
total  amount  of  $5,325.00. 
b.  Remodeling  of  a  boiler  house  at  a  total  cost  of  $4,500.00;  also, 
extending  same  at  a  total  cost  of  $6,200.(X);  both  of  these  being  done 
in  order  to  install  a  larger  and  more  modern  type  of  vertical  boilers. 
(•) 

166.  Indicate  how  you  would  distribute  the  following  expenditures: 

a.  Profit  of  $10,000.00  from  the  sale  of  stock  of  another  company  held 
as  an  investment.  The  broker's  commission  in  connection  with 
the  transaction  was  $750.00. 

b.  Loss  of  $500.00  from  the  sale  of  certain  bonds  held  as  an  investment. 
Loss  of  $5,000.00  from  the  sale  of  certain  real  estate  which  was  not 
required  because  of  moving  the  plant  to  another  locality.  (*) 
In  closing  the  books  of  a  firm  it  is  found  that  the  accounts  receiv- 
able include  $5,000.00  of  worthless  accounts,  and  $10,000.00  of 
doubtful  accounts.     The  firm  decides  to  deduct  from  the  gross 

^  profits  $15,000.00  for  these  items.     What  would  you  consider  the 

best  method  of  carrying  these  items  on  the  general  ledger? 
b.  In  the  case  of  a  company  which  pubhshes  an  annual  balance  sheet 
but  no  profit  and  loss  account,  state  whether  or  not  you  would 
recommend  to  your  client  that  the  profits  earned  during  the  year, 
less  dividends  paid,  be  shown  on  the  face  of  the  balance  sheet! 
Give  your  reasons.     (A.  I.  A.) 

168.  In  preparing  a  balance  sheet  as  of  December  31,  1921,  of  a  certain 
company,  how  would  you  treat  the  following,  and  why? 

a.  Estimated  cost  $26,000.00  to  replace  defective  parts  of  machines 
manufactured  and  sold  and  shipped  during  the  three  years  ending 
on  the  above  given  date.     (*) 

b.  Estimated  amount  $11,000.00  recoverable  from  the  company 
which  furnished  these  parts  to  us,  our  contract  with  them  providing 
that  all  parts  furnished  and  proving  defective  within  two  years 
from  date  of  shipment  are  to  be  replaced  free  of  charge  or  are  to  be 
paid  for  in  cash  at  reproduction  cost.     (*) 


QUESTIONS  AND  PROBLEMS 


589 


167. 


c. 


a. 


169.  a.  Set  up  a  form  of  working  paper  that  will  enable  an  auditor  to  adjust 

a  trial  balance  of  January  1,  with  a  profit  and  loss  account  and  a 
balance  sheet  of  a  subsequent  period  without  recourse  to  journal 
entries, 
b.  Is  the  form  of  a  balance  sheet  a  matter  of  principle  or  convention? 

170.  How  should  the  following  items  be  dealt  with  in  closing  the  books  on 
December  31,  1921:     (*) 

a.  Liabilities  of  $19,202.22  relating  to  the  period  prior  to  the  above 
date,  and  not  taken  up  onto  the  books  until  in  January,  1922. 
All  items  contained  in  this  total  represent  current  running  expenses 
of  a  general  nature. 

b.  The  inventory  at  December  31,  1921,  was  taken  up  on  the  books 
at  cost,  in  the  amount  of  $562,891.13;  the  market  value  of  this 
inventory  was  $537,688.29. 

c-  Investments  in  other  companies  were  taken  up  on  the  books  at 
market,  in  the  amount  of  $232,456.18,  whereas,  cost  was  $197,- 
243.96. 

171.  a.  Define  each  of  the  following  terma: 

1.  Surplus. 

2.  Undivided  profits. 

3.  Inventory  reserves 

b.  State  the  difference  between: 

1.  Plant  renewal  and  replacement  and  plant  repair. 

2.  Adjustment  entries  and  closing  entries. 

172.  a.  How  should  the  following  be  set  out  in  the  balance  sheet  of  a  com- 

pany:    (*) 

1.  Depreciation  reserve. 

2.  Sinking  fund  reserve. 

3.  Preferred  stock  dividends  in  arrears. 

b.  Explain  the  difference  between  cost  and  book  value. 

173.  a.  What  constitutes  selling  cost? 

b.  Should  freight-out  be  shown  as  a  deduction  from  gross  sales,  as  an 
addition  to  the  cost  of  goods  sold,  or  as  a  selling  exi>ense?     Why? 

c.  Distinguish  between  the  items  allocatable  to  the  trading  account 
and  to  the  profit  and  loss  account. 

d.  Distinguish  between  gross  profit  and  net  profit. 

174.  a.  How  should  the  following  items  be  distributed  in  the  accounts  of  a 

company:     (*) 

1.  Bonuses  paid  to  oflScers  and  employees,  $15,000.00. 

2.  Purchase  of  $100,000.00  of  the  preferred  stock  of  the  XYZ 
Company,  for  $120,000.00,  this  being  the  purchase  of  the  total 
par  value  of  the  stock  issued  by  the  XYZ  Company. 

b.  May  any  fluctuation  in  the  value  of  permanent  assets  be  permitted 
to  affect  the  result  of  the  profit  and  loss  account?     Give  reasons. 

175.  a.  In  making  up  a  profit  and  loss  statement  at  the  close  of  a  fiscal 

year,  are  you  stating  a  fact  or  an  opinion?     Give  reasons? 
b.  What  are  the  limitations,  if  any,  of  a  balance  sheet? 


590 


ADVANCED  ACCOUNTING 


176.  a.  A  company  shows  among  its  assets  $2,675.00  as  unexpired  insurance 

on  January  1,  1922.     On  February  1,  1922,  the  plant  is  destroyed 
*  by  fire  and  a  total  loss  of  $57,875.00  occurs,  which  the  insurance 

company  pays.  How  would  you  treat  the  $2,675.00  unexpired 
insurance  item? 
b.  A  manufacturing  corporation  having  several  plants  decides  to 
shut  down  one  plant  because  it  cannot  be  run  economically.  Under 
what  classification  in  the  operating  statement  would  you  include 
the  expenses  attending  the  care  and  upkeep  of  the  idle  plant? 

177.  a.  What  is  meant  by  turnover?     Illustrate  its  modem  usefulness, 
b.  Why  must  the  revenue  account  be  completed  before  a  balance 

sheet  can  be  prepared? 

178.  a.  State  two  different  theories  in  relation  to  the  presentation  of  a 

balance  sheet  as  far  as  classification  is  concerned.     What  is  the 
reasoning  on  which  they  are  based? 
b.  What  is  the  mechanism  of  the  double  form  balance  sheet?     Explain 
the  connection  between  its  sections,  stating  the  theory  of  the 
organism. 

179.  a.  Distinguish  between  the  following: 

1.  Contingent  asset  and  contingent  liability. 

2.  General  balance  sheet  and  comparative  balance  sheet, 
b.  When  do  revenue  expenditures  create  assets? 

180.  a.  In  auditing  the  accounts  of  a  manufacturing  company  would  you 

consider  it  proper  to  allow  the  profit  and  loss  account  to  be  credited 
with  profit  on  uncompleted  work? 
b.  What  accounts  on  the  ledger  are  generally  considered  as  "deduc- 
tions from  income  "  ?     Why  ?     As  "  other  income ' '  ? 


PROBLEMS   ON   CHAPTER  IX 
41 

Trial  Balance  of  the  General  Ledger  of 
John  Doe,  Civil  Engineer,  December  31,  1911 
$10, 572 .44     M  an  hattan    Construc- 
1,054.68    tion, 

Report  No.  1,  Sewanee 
6,000.00     Creek  Raiboad, 
15,457.50    Report  No.  2,  Engle- 
3,000.00    wood  Reservoir, 

Report    No.    3,    Long 
13 ,  000 .  00    Acre  Library, 
15 ,  361 .  32    Connecticut  Tramways 
9,800.00     Company, 
1 ,  060 .  00    Earnings — consulting 
Report  fees, 


Cash, 

Furniture  and  fixtures, 
Real    estate    (Ruther- 
ford home), 
Investments  in  stocks, 
Investments  in  bonds, 
Missouri  Pacific — 
margin  account, 
Accounts  receivable, 
General  expense. 
Interest, 


Sharj)  &  Co.,  brokers, 
Sto<;kH  and  bonds. 
Capital, 


$75,305  94 


$  5,000.00 

5,300.00 

4,600.00 

3,200.00 

1,960.00 

2,000.00 

16,000.00 

11,310.00 

4,300.00 

21,745.94 


QUESTIONS  AND  PROBLEMS 


591 


Analyses: 

General  expense— Salaries:  John  Doe,  $6,000.00,  other  salary  $1,800.00; 
rent  $1,000.00;  advertising  $600.00;  cables  and  telegrams  $90.00;  stationery 
and  printing  $110.00;  other  expenses  $200.00. 

Interest— Debited  with  $1,300.00  charged  by  Sharp  &  Co.,  brokers,  on 
margin  account;  reduced  by  dividends  of  $390.00,  credited  by  Sharp  &  Co. 
on  margin  account.     Balance  on  loans  since  repaid. 

Manhattan  Construction  Co. — Represents  consulting  fees  received 
during  the  year  1911,  the  contract  running  from  month  to  month,  with 
no  expense  to  John  Doe. 

Reports  1-3 — Are  completed  and  delivered.  Account  contains  fees, 
less  expenses. 

Connecticut  Tramways  Co.— Represents  $2,000.00  received  November  1, 
1911,  and  expenses  of  $50.00;  according  to  terms  of  contract,  John  Doe  is  to 
act  as  consulting  engineer  for  ten  months  and  to  receive  altogether  $5,000.00. 

Report  Fees — Fees  received  under  contract  for  report,  $9,000.00  received 
on  contracts  on  which  no  work  has  been  done;  balance  is  earned. 

Stocks  and  Bonds — Are  sold.     Account  represents  balance. 

Additional  Facts— Dividends  on  stocks  received  during  the  year  amount 
to  $1,985.00  of  which  $1,000.00  was  applied  to  the  account  Investment  Stocks 
and  $985.00  was  applied  to  Stocks  and  Bonds  sold. 

Prepare: 

a.  A  balance  sheet  at  December  31,  1911. 

b.  An  income  statement  showing  John  Doe's  true  earning  power  as  a 
civil  engineer. 

c.  The  journal  entries  supporting  your  adjustments  of  the  books,  if  any. 


Black  and  White  were  partners  upon  the  following  terms: 

1.  They  were  to  receive  5  per  cent  interest  upon  their  respective  partnership 
capital. 

2.  They  were  to  receive  partnership  salaries  as  follows:  Black,  $250.00 
per  month  and  White,  $100.00  per  month,  and  they  were  to  draw  no 
further  sums,  pending  the  ascertainment  of  profits. 

3.  Depreciation  at  10  per  cent  per  annum  to  be  written  off  plant  and 
machinery  as  standing  on  the  books  at  the  close  of  the  year. 

4.  Provision  at  5  per  cent  (for  doubtful  accounts)  to  be  reserved  for  all 
accounts  receivable,  not  including,  however,  bills  receivable. 

5.  The  net  profit  or  loss  to  be  shared  as  follows:  Black,  two-thirds,  and 
White,  one-third. 

On  November  30,  1915,  the  following  was  the  trial  balance  of  the  firm's 
books,  which  were  kept  by  double  entry: 


Partners'  salary  account, 
Purchases, 

Investments  (at  cost). 
Wages, 


$    3,850.00 

127,310.00 

6,150.00 

19,205.00 


$75,305.94 


I 


I 


592 


ADVANCED  ACCOUNTING 


John  Jones  &  Co., 

Jas.  Smith  &  Son, 

Wm.  Owen, 

Legal  expenses, 

Cash, 

Bank, 

Real  estate. 

Machinery  and  plants, 

Bills  receivable. 

Manager's  and  clerks'  salaries. 

Office  expense. 

Discount, 

Inventory,  Jan.  1,  1915, 

Rent  (eleven  months), 

Albert  Black  (Capital  account  on  1/1/15), 

Benjamin  White  (Capital  account  on  1/1/15), 

Dividends  received  on  investments, 

Bills  payable. 

Sales, 

Roberts  Bros., 

Robinson  &  Co., 

J.  Green  &  Son, 


17,130.00 

35,695.00 

18,120.00 

130.00 

50.00 

6,025.00 

103,205.00 

27,200.00 

2,510.00 

4,725.00 

540.00 

1,070.00 

19,210.00 

3,300  00 

I  21,000.00 

7,500.00 

150.00 

19,076.00 

242,806.00 

41,216.00 

28,840.00 

34,840.00 

$395,425.00    $395,426.00 


Amend  the  foregoing  balances  so  far  as  may  be  necessary  by 
following  transactions  for  the  month  of  December,  1915: 
Dec.    2. — Purchased  from  Roberts  Bros,  on  credit, 
8. — Paid  taxes, 
9. — Paid  Robinson  &  Co.  (after  deducting  discount  of 

$60.00), 
10. — Paid  bill  payable  to  H.  Brown  &  Co., 
11.— Received  from  J.  Smith&Co.  (less  discount  of  $210.00), 
12. — Sold  Wm.  Owen  (on  credit), 
15. — Purchased  from  J.  Green  &  Son  (on  credit), 
16.— Bought  gas  engine  from  Al-Ki  Gaa  Engine  Co.  (on 

Credit), 
17. — Paid  wages, 
21. — Paid  taxes, 
24. — Paid  premium  on  fire  insurance  policy  for  year 

ending  Dec.  24,  1916, 
30. — Received  for  sale  of  investments, 
31. — Paid  office  salaries. 
Paid  office  expenses, 
Paid  wages, 
Sold  James  Smith  &  Co.  (on  credit), 


posting  the 

$39,206.00 
705.00 

1,200.00 

500.00 

4,740.00 

5,000.00 

17,106.00 

1,750.00 

2,210  00 

106.00 

526.00 
6,000.00 
1,800.00 

100.00 
2,200.00 
5,246.00 


All  the  above  payments  were  made  by  check,  and  all  amounts  received 
were  paid  into  the  bank  upon  receipt.     The  stock  on  hand  on  Dc^cember  31, 


Ti 


QUESTIONS  AND  PROBLEMS 


593 


from  the  books  of  the  Moore  & 
1914: 


f        100.00 
3,000.00 


150,000.00 
10,000.00 

50,000.00 

200,000.00 

50,000.00 

5,000.00 

5,000.00 

2,000.00 

5,000.00 

900,000.00 

20,000.00 

25,000.00 

10,000.00 

5,000.00 

5,000.00 

2,000.00 

1,500.00 

300,000.00 

3,000.00 

2,000.00 
3,000.00 
50,000.00 
20,000.00 
11,000.00 
10,000.00 
12,000.00 


$1,150,000  00 

20,000  00 

1,000  00 


200,000.00 


1915,  was  agreed  by  the  partners  as  worth  $17,000.00.  The  outstanding 
rent  due  to  Benjamin  &  Lewis  for  December,  $300.00,  and  the  partners' 
drawmgs  for  the  same  month  must  be  provided  for.  After  making  aU 
adjustments  provided  for  in  the  clauses  of  the  partnership  agreement 
balance  the  books  as  at  December  31,  1915,  and  prepare  trial  balance;  alflci 
prepare  an  mcome  and  profit  and  loss  statement  and  balance  sheet. 

43 

The  following  trial  balance  was  taken 
Smith  Hardware  Company,  December  31, 
Cash  on  hand. 
Cash  in  bank. 
Sales, 

Discounts  on  purchases. 
Interest  on  notes  receivable, 
Accounts  receivable. 
Notes  receivable. 
Capital  stock, 
Real  estate. 
Buildings, 
Equipment, 

Horses,  wagons  and  harness, 
Motor  trucks. 
Insurance, 
Taxes, 
Purchases, 

Discounts  on  sales — cash, 
Wages  of  men  in  warehouse, 
Salaries  of  department  managers. 
Salaries  of  office  assistants. 
Drivers,  teamsters,  etc.. 
Horse  feed. 
Auto  expense. 
Inventories,  Jan.  1,  1914, 
Inventories,  horse  feed,  auto  accessories, 
etc.,  Jan.  1,  1914, 

Inventories,  stationery,  advertising,  etc., 
Jan.  1,  1914, 

Office  supplies,  stationery,  etc.. 

Advertising, 

Salesmen's  salaries. 

Salesmen's  commissions. 

Interest  on  notes  payable. 

Dividend  on  capital — 6  per  cent, 

Notes  payable, 

Accounts  payable. 

Real  estate — not  used  in  the  business. 

Investment  in  Union  Hotel  Co.  (at  cost), 


150,000.00 
50,000.00 


250,000.00 
150,000.00 


w 


594 


ADVANCED  ACCOUNTING 


Sprinkler  system — at  face  of  contract, 

Surplus, 

Liability  on  sprinkler  sj'stem, 


10,000.00 

290,600.00 

8,000.00 

12,069,600.00    $2,069,600.00 


On  December  31,  1914,  the  company  authorized  the  issue  of  $300,000.00 
cumulative  7  per  cent  preferred  stock  and  sold  wame  to  the  Grand  Investment 
Company  at  90,  giving  also  a  bonus  of  $30,000.00  common  stock.  $70,000.00 
conmion  stock  was  sold  to  the  present  stockholders  at  par,  the  total  issue 
of  common  stock  being  $300,000.00.  Of  the  proceeds  of  these  sales  $150,- 
000.00  was  to  be  expended  on  new  buUdings,  the  balance  to  be  retained  for 
working  capital. 

On  January  2,  1915,  a  dividend  of  $40,000.00  was  declared,  i»ayable  on 
January  15,  1915. 

The  inventories  at  December  31,  1914,  were: 
Merchandise,  $325,000.00 

Horse  feed,  auto  accessories,  etc.,  1,000.00 

Stationery,  advertising,  etc. ,  i ,  500  00 

Of  the  insurance  paid  $500.00  appUes  to  the  year  1915;  aliio  $1,500.00 
of  the  taxes. 

The  sprinkler  system  was  installed  on  July  1,  1914.  Of  the  contract 
price  $2,000.00  was  paid  on  that  date  and  $2,000.00  is  payable  on  the  first 
day  of  August,  1915,  1916,  1917,  1918. 

$2,000.00  of  interest  applies  to  the  period  subsequent  to  January  1,  1915. 

The  depreciation  of  buildings  for  the  year  is  $10,000.00  and  of  equipment 
$5,000.00.  The  real  estate  not  used  in  business  has  appreciated  $50,000.00, 
while  that  used  in  business  has  been  appraised  at  $75,000.00. 

From  the  foregoing  trial  balance  and  data  prepare  a  statement  of  income 
and  profit  and  loss  for  the  year  and  a  balance  sheet  as  at  December  31,  1914. 


44 

The  following  is  the  trial  balance  of  the  ledger 
Company,  at  the  close  of  business  on  December 
Capital  stock. 
Work  in  process  12/31/19, 
Materials  inventory  12/31/19, 
Finished  product  12/31/19, 
Une3^ired  insurance, 
Taxes, 

Materials  purchased, 
Insurance, 
Interest, 

Accounts  payable. 
Accounts  receivable. 
Traveling  expenses. 
Factory  supplies. 
Office  expenses. 
Selling  expenseSi 


of  the  Jones  Manufacturing 
31,  1920: 

$150,000.00 

$  53,689.39 

10,767.87 

115,453.90 

5,458.00 

2,937.50 

160,691.26 

4,567.80 

4,200.00 


45,897.57 
3,654.62 
5,670.03 
4,790.82 
8,798.46 


23,570.98 


QUESTIONS  AND  PROBLEMS 


595 


Petty  cash, 

Power, 

Cash  in  bank, 

Notes  payable, 

Labor, 

Machinery  and  equipment, 

Factory  expense. 

Discount  on  sales, 

Freight-out, 

Freight-in, 

Discount  on  purchases. 

Salesmen's  commissions, 

Taxes  prepaid, 

Repairs, 

Rent, 

Salaries, 

Interest  prepaid. 

Reserve  for  depreciation, 

Sales, 

Surplus, 


200.00 
6,400.00 
3,609.00 

186,568.43 

124,357.00 

51,800.05 

3,675.47 

2,657.80 

2,748.56 

6,600  66 

672.80 

5,346  00 

12,000.00 

34,846.00 

345.00 


50,000.00 


7,896.41 


29,670.00 

562,109  70 

45,156  90 

T.,  ^  ^.                                                                     $868,403.99    $868,403.99 
Notations: — * 

1.  Inventories  on  hand:  materials,  $10,434.22;  work  in  process,  $56,542  14' 
finished  product,  $70,470.89;  supplies,  $3,567.90. 

2.  Prepaid  interest  amounts  to  $350.00;  prepaid  taxes  amount  to  $578  00- 
unexpired  insurance,  $987.56.  ' 

3.  Reserve  for  depreciation  to  be  increased  5  per  cent  of  the  total  fixed 
assets. 

4.  Reserve  for  uncollectible  accounts  receivable  to  be  2  per  cent  of  the 
total  accounts  receivable. 

5.  Insurance,  taxes,  and  rent  are  to  be  divided  3/5  to  the  factory    1/5 
to  trading,  and  1/5  to  administration.  ' 

Required : 

1.  Working  sheet  with  accompanying  schedules  of  adjusting  entries. 

2.  Statements: 

a.  Balance  sheet. 

b.  Statement  of  profit  and  loss. 

c.  Statement  showing  cost  of  manufucture  and  cost  of  manufactured 
product  sold. 

At  the  close  of  its  fiscal  year,  December  31,  1915,  the  trial  balance  of  the 
rslau-I'ace  Company  was  as  follows: 

Real  estate,  $  225,000.00 

Fixed  machinery,  150,000.00 

Movable  equipment,  jg  qqq  qq 

Shaftings,  pulleys,  etc.,  10*500  00 

Stable  equipment,  3 ,'  500 .  00 

Office  equipment,  2  915  on 


596 


ADVANCED  ACCOUNTING 


Drawings  and  patterns, 

9,000.00 

Patents, 

75,000.00 

V  Capital  stock, 

$  500,000.00 

i  First  mortgage  bonds. 

100,000.00 

.  Profit  and  loss, 

,  Surplus, 

86,140.00 

^  Dividends, 

300.00 

•^  Interest  on  bonds, 

6,000.00 

>■  Other  interest  paid, 

1,323.10 

t  Interest  received, 

2,469.50 

t  Cash  discount  on  purchases, 

13,389.52 

,  Cash  discounts  on  sales. 

2,861.50 

-  Sales, 

1,540,816.75 

*  Return  sales, 

8,258.25 

'  Ca«h, 

27,750.65 

-  Bills  receivable, 

60,750.00 

.  Accounts  receivable, 

298,650.25 

.  Raw  materials, 

622,190.90 

•  Finished  goods,  Jan.  1,  1915, 

62,735.06 

V  Goods  in  process,  Jan.  1,  1915, 

24,747.27 

»  Fuel, 

38,688.28 

,^  Insurance, 

4,000.00 

Taxes, 

6,000.00 

*   Bills  payable. 

40,000.00 

^   Accounts  payable, 

46,585.85 

1-  Reserve  for  depreciation: 

V      Machinery  and  equipment. 

60,000.00 

Buildings, 

30,000.00 

'       Patents, 

22,058.80 

Bad  accounts. 

6,240.75 

K    Salaries — OflScers  and  clerks  (general). 

66,150.00 

General  office  supplies, 

2,950.75 

Postage,  telegraph,  and  telephone. 

1,560.00 

Miscellaneous  general  expenses, 

850.00 

I,-  Advertising, 

35,000.00 

i   Salaries  and  expenses — salesmen. 

72,350.31 

t  Agents'  commissions, 

30,141.40 

.  Credit  department  salaries. 

7,560.00 

Miscellaneous  expenses — Selling, 

610.00 

Stable  expenses, 

3,963.46 

V  Direct  labor  (manufacturing), 

508,311.39 

V  Indirect  labor  (manufacturing). 

44,981.01 

«-  Superintendence — Factory, 

6,000.00 

'    Factory  supplies. 

8,547.18 

"  Repairs — Machinery  and  equipment, 

7,418.52 

^  Repairs  of  buildings. 

2,860.47 

^  Power,  heat,  and  light, 

2,875.80 
$2,438,001.45 

$2,438,001.45 

QUESTIONS  AND  PROBLEMS  597 

You  are  to  take  into  consideration  the  following  facts: 

1.  Real  estate,  machinery  and  other  factory  equipment,  and  patents 
are  stated  at  cost. 

2.  Of  the  real  estate,  $25,000.00  is  for  land,  and  $200,000.00  is  for 
buildings. 

3.  All  capital  stock  authorized  has  been  issued  and  is  outstanding. 
.  4.  Allowances  for  depreciation  are : 

Machinery  and  factory  equipment,  $15,000.00. 
Buildings,  3  per  cent  of  cost. 
Patents,  1/17  of  cost. 

5.  $15,000.00  is  to  be  set  aside  as  a  reserve  for  bad  accounts. 

6.  Ten  per  cent,  of  the  book  value  of  stable  equipment  and  office  equip- 
ment, and  one-sixth  of  the  book  value  of  drawings  and  patterns  are 
to  be  charged  oflf. 

7.  Inventories  at  the  close  of  the  fiscal  year  were: 
Raw  materials. 
Finished  goods. 
Goods  in  process. 
Fuel, 

Factory  supplies. 
Office  supplies. 
Prepaid  insurance, 

8.  The  accruals  are: 
Taxes, 

Direct  labor. 
Indirect  labor, 
Interest  on  bonds. 
Advertising, 


$63,580  40 

58,864.56 

27,024.52 

4,823  43 

1,525  00 

500  00 

500.00 


;  7,000  00 

12,618  75 

2,040  50 

1,000  00 

4,718.50 


$27,377.75 

9.  The  depreciation  of  stable  equipment  (see  it€m  6)  is  to  be  charged  to 
stable  expenses,  and  one-third  of  the  latter  is  apportioned  to  manufac- 
turing expenses,  and  two-thirds  to  selling  expenses. 

10.  The  cost  of  fuel  used  is  to  be  charged  to  power,  hght,  and  heat. 

11.  Maintenance  of  real  estate  is  to  be  charged  with  cost  of  repairs  to 
buildings,  depreciation  of  buildings,  20  per  cent  of  taxes  for  the  year, 
and  $1,000.00  for  insurance.  The  total  cost  of  such  maintenance  is  to 
be  shown  as  an  item  of  manufacturing  expense  on  the  statement  of 
cost  of  sales. 

12.  The  portion  of  insurance  remaining  after  charging  maintenance  of 
real  estate  is  to  be  allocated  to  manufacturing  expenses. 

13.  Thirty  per  cent,  of  the  taxes  for  the  year  is  to  be  apportioned  to 
manufacturing  expense  and  50  per  cent  is  to  be  charged  to  income. 

14.  Of  the  salaries  of  officers  and  clerks  (general),  $3,600.00  should  be 
apportioned  to  selling  expenses. 

15.  Amongst  the  bills  receivable  is  a  note  for  $5,000.00,  pertaining  to  a 
previous  fiscal  year,  which  is  considered  to  be  worthless.  No  pro- 
vision was  made  for  such  loss. 


598 


ADVANCED  ACCOUNTING 


16.  Regardless  of  theory,  cash  discounts  on  purchases  and  salew  are  to  be 
treated  as  pertaining  to  income. 

17.  On  December  10,  1915,  a  dividend  of  10  per  cent  on  the  capital  stock 
was  declared  and  made  payable  on  January  10,  1916,  for  which  no 
entry  was  made  prior  to  taking  off  the  trial  balance. 

Given  the  foregoing  information,  you  are  asked  to  prepare  the  following 
statements  in  approved  form  for  the  information  of  your  clients: 

a.  Cost  of  sales. 

b.  Profit  and  loss,  showing  (1)  the  gross  pro6t  and  the  per  cent,  of  same 
on  sales;  (2)  the  selling  expenses  and  per  cent,  of  same  (»n  the  gross 
profit;  (3)  the  general  expenses  and  the  jx^rcentage  that  such  -expenses 
bear  to  the  gross  profit;  and  (4)  the  net  profit  and  the  p«?r  cent,  of 
same  on  sales. 

c.  Balance  sheet,  showing  the  surplus  at  the  beginning  of  the  fiscal  year 
and  the  amount  at  the  close  of  the  year. 


181. 


b. 
182.  a. 


183. 


a. 


QUESTIONS   ON   CHAPTER    X 

Twenty  Questions,  Five  Problems 
What  significance  would  you  attach  to  the  fact  that  in  a  two  million 
dollar  manufacturing  concern,   the   cash  on  hand  and  in   bank 
amounts  to  $3,167.22?     Why? 

What  is  meant  by  marshalling  the  accounts  of  a  balance  sheet? 
The  Good  Music  Company,  vendors  of  all  kinds  of  musical  instru- 
ments, shows  on  its  balance  sheet  notes  receivable  equal  to  about 
2/3  of  the  total  assets.     What  deductions  do  you  draw  from  this 
fact?     (♦) 

Is  strict  accuracy  necessary  as  to  the  facts  possible  in  a  balance 
sheet?     Why? 

As  between  two  consecutive  years,  it  is  noticed  that  the  item  of 
accounts  receivable  upon  a  comparative  balance  sheet  ha«  decreased 
nearly  $20,000.00.     What  might  such  a  decrease  indicate?     (♦) 
b.  Give  the  method  of  preparing  a  balance  sheet  where  ledgers  have 
not  been  closed. 

184.  a.  In  a  wholesale  dry  goods  concern,  the  net  sales  for   1920  were 

$1,495,000.00.  The  balance  sheet  for  the  year  showed  an  accounts 
receivable  item  of  $373,500.00.  Does  any  connection  exist  between 
these  items  to  which  attention  should  be  directed  when  analyzing 
the  balance  sheet  for  credit  purposes?  (*) 
b.  On  what  important  points  will  the  balance  sheet  of  a  trading  and 
non-trading  company  differ? 

185.  a.  The  merchandise  item  upon  a  certain  balance  sheet,  allowing  for 

the  usual  profit,  is  about  1/3  the  sales  for  the  past  year.  Does 
this  fact  have  any  significance  in  the  granting  of  credit  to  this 
enterprise?  (*) 
b.  Outline  the  forms  of  the  profit  and  loss  statement  and  of  the 
balance  sheet  as  submitted  by  the  Federal  Reserve  Board  in  their 
proposal  for  a  uniform  system  of  accounting  to  be  adopted  by 
manufacturing  and  merchandising  concerns. 


QVESTff^NS  AND  PROBLEMS 


599 


187. 


186.  The  inventory  item  in  the  balance  sheet  of  a  leather  manufacturer  is 
shown  subdivided  as  follows: 

Finished  leather  and  cut  soles,  $442,891 .27 

Leather  in  process,  246 ,  742 .  30 

Leather  on  consignment,  1 10 ,  22 1 .  80 

Rawhides,  75,438.19 

Tanning  and  other  supplies,  82,664  28     $957 , 957 . 84 

Can  you  offer  any  criticism  on  the  above?     If  so,  what? 

a.  In  a  statement  of  a  meat  packing  house,  the  asset  of  merchanidse 
is  equal  to  about  1/12  of  the  sales  for  the  year.  Is  this  as  it  should 
be?     (*) 

b.  What  items  would  you  designate  as  "quick  assets"? 

188.  a.  In  the  balance  sheet  of  a  wholesale  dry  goods  concern,  out  of  a 

total  amount  of  fixed  assets  of  $50,000.00,  the  item  of  furniture  and 
fixtures  equals  $21,000.00.  The  remaining  fixed  assets  consist  of 
real  estate  $10,000.00,  and  outside  investments  of  $19,000.00. 
What  conclusion  may  be  drawn  from  the  above?  (♦) 
b.  Give  two  examples  of  fixed  assets  in  a  business  which  become 
floating  assets  in  another  business. 

189.  One  of  the  footnotes  to  a  certain  balance  sheet  reads: 
"Insurance  1920-1921—85  oer  cent." 

Explain  the  meaning  of  this  footnote.     (♦) 

190.  In  a  certain  balance  sheet  the  cash  item  is  twice  the  size  of  the  accounts 
payable;  likewise,  the  notes  payable  item  amounts  to  $250,000.00. 
What  deductions  may  be  drawn  from  the  above  facts  standing  by 
themselves?  Would  your  answer  be  the  same  if  the  notes  payable 
item  amounted  to  $210,111.00? 

191.  a.  What  features  should  one  expect  to  be  in  evidence  in  a  good  balance 

sheet  of  a  department  store?     (•) 
b.  Give  instances  of  the  manner  in  which  fixed  assets  and  floating 
assets  affect  the  stabUity  and  the  credit  of  a  business. 

192.  a.  In  a  statement  submitted  to  a  bank  by  a  plumbers'  supply  house, 

out  of  a  total  amount  of  assets  of  $550,000.00,— the  inventory 
consists  of  $280,000.00,  the  notes  receivable  of  $35,000.00,  and  the 
accounts  receivable  of  $200,000.00,— in  round  numbers.  What 
comments  would  you  make  upon  these  items?  (*) 
b.  What  is  the  theory  applying  to  deferred  debits  shown  in  a  balance 
sheet? 

193.  The  balance  sheet  of  a  firm  is  summarized  as  follows: 


Assets: 

Cash,  stock  and  accounts  receivable, 

Manufacturing  plant. 

Liabilities: 

Notes  and  accounts  payable, 
Capital, 


$67,500.00 
15,00000 


$49,500.00 

33,000.00 

$82,500.00    $82,500.00 


Would  you  consider  this  firm  solvent?    Give  reasons  for  your  answer. 


600 


'ADVANCED  ACCOUNTING 


194.  Draw  up  a  short  report  on  the  following  balance  sheet,  criticizing 
such  items  as  you  consider  abnormal : 


Buildings, 

Machinery, 

Sundry  stock, 

Cash, 

Bills  receivable. 

Customers, 


$87 ,  500 .  00    Capital  and  surpl  us,  $  1 55 ,  000 .  00 


Good-will  and  patents,     30,000.00 

$250,000.00 


12 ,  500 . 00     ( ^urrent  habihties, 
90,000.00     Suspense  account, 

3,200.00 

6,800.00 
20,000.00 


87,500.00 
7,500.00 


$250,000.00 


195.  Arrange  the  following  in  a  balance  sheet  for  presentation  to  a  banker: 

Furnitiu-e  and  fixtures,  $15, 000 .  00 

Stock  of  merchandise  at  cost,  50,000.00 

Accounts  receivable,  35 ,  ooo  00 

Officers'  accounts,  30,000.00 

Bonds  owned,  10 ,  000 .  00 
Capital  stock, 
Accounts  payable. 
Trade  notes  payable, 
Surplus, 


$75,000.00 

20,000.00 

40,000.00 

5,000.00 


$140,00000    $140,000.00 

196.  The  High  Pressure  Valve  Manufacturing  Company  submit  tho 
following  balance  sheet  taken  from  their  books  in  connection  with 
the  facts  enumerated;  the  organization  is  highly  skilled  and  dependent 
upon  cooperation.  Give  your  recommendations  as  to  what  should  be 
done  to  serve  the  interest  of  the  business: 

Plant,  $14,500.00;  accounts  receivable,  $4,000.00;  ciwh,  $1,510.00; 
capital  stock,  $15,000.00;  loan  payable,  $3,000.00;  accounts  payable,' 
$4,000.00;  notes  payable,  $3,500.00;  sales,  $16,000.00;  cost  of  sales] 
$10,000.00;  general  expense,  $2,000.00;  selling  expense,  $3,500.00; 
deductions  from  income,  $4,000.00.  The  valves  are  in  demand  and  in 
general  use. 

197.  Jones,  a  trader,  commences  business  July  1,  1920,  with  a  capital 
consisting  of  caah,  $100,000.00;  land  and  buildings  worth  $80,000.00, 
subject  to  a  mortgage  of  $30,000.00. 

An  abstract  of  his  books  July  1,  1921,  discloses  the  following  accounts: 
Purchases,  $75,000.00;  sales,  $90,000.00;  cash  expenses,  $15,000.00; 
cash  drawings,  $8,000.00;  profit  and  loss  debit,  $5,000.00;  sinking 
fund,  $5,000.00;  goods  returned  to  creditors,  $4,000.00;  returned  sales, 
$3,000.00;  contingent  fund,  $2,000.00;  reserve  for  bad  debts,  $5,500.00; 
due  sundry  creditors,  $61,000.00;  sundry  customers,  $34,480.00; 
discounts  allowed  customers  on  accounts  paid,  $520.00;  no  goods 
were  sold  to  creditors  or  purchased  from  customers. 
Inventory  July  1,  1921,  $7,000.00.  Interest  on  mortgage  6  per  cent- 
Supply  the  missing  accounts,  and  furnish  an  adjusted  trial  balance 
from  which  the  usual  statements  may  l)e  prepared.     (*) 


QUESTIONS  AND  PROBLEMS 


601 


198.  An  auditor  is  called  upon  to  verify  a  balance  sheet  and  upon  investi- 
gation he  finds  that  unexpired  insurance,  interest  paid  in  advance 
on  discounted  notes,  taxes  accrued,  interest  accrued  on  demand 
notes,  bonded  indebtedness,  royalties,  etc.,  are  not  included  in  the 
same.  He  is  informed  that  it  has  not  been  the  custom  of  the  corpora- 
tion to  include  in  their  balance  sheet  such  items,  as  they  offset  one 
another,  and  that  the  directors  do  not  desire  any  change  in  the  practice 
they  have  adopted.  Discuss  this  proposition,  stating  reasons  for 
your  conclusions. 

199.  A  corporation  wishes  to  get  figures  of  its  earnings  early  each  month. 
Besides  its  regular  income,  it  has  bonds  and  stocks  from  which  the 
interest  and  dividends  are  received  either  quarterly  or  semi-annually. 
It  has  trouble  in  getting  some  of  its  exp)ense  bills  promptly,  as  some 
come  in  quarterly,  semi-annually,  and  even  yearly.  State  the  method 
of  getting  out  promptly  with  as  little  work  as  possible  these  monthly 
figures. 

200.  a.  Under  what  circumstances,  if  any,  may  capital  expenditures  be 

charged  against  revenue? 

b.  In  the  audit  of  the  accounts  of  a  corporation  for  a  year  in  which 
the  business  has  made  a  loss  and  at  the  close  of  which  no  profits 
are  available  for  dividends,  would  you  consider  it  your  duty  to 
direct  the  same  attention  as  usual  in  distinguishing  between 
expenditure  on  fixed  assets  chargeable  to  capital  and  that  charge- 
able against  operations?     Give  your  reasons. 

c.  Expenditures  are  made  by  a  corporation  for  items  of  each  of  the 
following  classes:  (a)  Taking  down  a  machine  in  one  part  of  a 
factory,  moving  it  and  putting  it  up  in  another  part;  (b)  expenses 
of  incorporating  the  company,  including  State  charges  and  lawyer's 
services;  (c)  brokerage  on  purchase  of  a  piece  of  property;  (d)  commis- 
sion on  an  issue  of  debenture  bonds;  (e)  costs  attending  a  mortgage; 
(f)  furniture  and  fittings  of  a  city  office  and  salesroom;  (g)  cost  of 
patents,  including  solicitor's  charges  and  government  fees.  Which 
items  should  be  charged  to  capital  and  which  to  revenue?  State 
reason  for  your  answer  in  each  case. 


PROBLEMS   ON   CHAPTER    X 
46 

You  are  employed  to  prepare  a  statement  for  credit  purposes  from  figures 
submitted  to  you  in  a  letter  from  the  Western  Manufacturing  Company. 
Their  letter  submits  figures  and  data  as  follows: 

Their  plants  stand  at  cost  price,  $90,600.00.  They  have  set  up  a  reserve 
for  depreciation  of  $15,300.00.  There  is  a  mortgage  of  $30,000.00  on  the 
plant  and  interest  on  the  mortgage  is  at  6  per  cent  and  is  paid  to  within 
three  months  of  date  of  your  proposed  statement.  They  hold  $15,000.00 
of    notes  receivable    and  have  discounted  at  bank  $37,500.00.     Accounts 


t 


602 


ADVANCED  ACCOUNTING 


receivable  they  consider  good,  amount  »27nnnnn    •     i  j- 
due  from  employee  on  personal  ^ooZt      KT,^^tht:lf"^ .  ^''^'^ 
subject  to  6  per  cent  discount  if  paid  at  due  dateTnr*n  f^^,^       ™"^  ""^ 
due.     Suspense  ac<-ounte  amount  to  »i  (L  m    ^     »15,0(XI.OO  is  now  past 
beUevedtobegood.    A  new  machin^  ^  ^     '  f  ^'  "*"'  °'  "^ich  are 

which  cost  ,,,Lm.    Th:;hTv:tdt:  TnVtetrt  ^r  f^^'^^^^^^ 
Co.,  but  say  it  wiU  be  paid  when  d..P      1        '*/'"^  J9,000.00  for  .Smith  and 
000.00,  insurance  amouiTto  l^f^  /"<="""*«  P^yaWe  amount  to  $6;!,- 
They  owe  a  note  at  ban",^^   T  T**  ^T  "'  '"°"*'"  *"  ^""• 
fifty  shares  of  stock  in  a  commnv  fZ,?^       I*^*  E""^  *°  '^''**-     They  own 
cost  ,4,200.00,  and  a^e ^rum^e^T  t ToSs"' t'''^  T*^ "'''''•     '^'"'^ 
at  a  selling  price  of  10  per  cent  more  tha^c^t     Th       ^""""^"'y  *>«  taken 
You  are  not  asked  to  accept  Tv  r^Tn  ^  r.  ^   '  T""'"*'  *°  »2fl,400.0(). 
ment  but  simply  to  premTtbZlTr    !'    VV^^  ^'^'"'■^  '"  ^^e  statc- 
their  letter.  ^  ^       *^^  statement  m  the  best  form  you  can  from 

47 

yield  very  large  pr<Z      Cal^,^  ,»      government,  which  is  expected  to 

plant,  as  well  L  T  Ik^gtl  of  Si°;";"^.  *"<'  "^  «>'  »". 

the  statement  for  the  bauker'alTcol'Tntti^ronSmTh     ^""''^ 
ant's  standpoint.  ""eny  on  it  from  the  account- 


Real  estate, 
Capital  stock, 
Machinery, 

Advances  on  contract*, 
Buildings, 
Accounts  payable, 
Work  in  process, 
Surplus, 

Material  and  supplies. 
Cash, 
Good- will. 
Deferred  charges. 
Accounts  receivable, 


July  31,  1917 


S  90,000.00 

10,000.00 

40,000.00 

10,500.00 

8,000.00 
3,500.00 
30,000.00 
2,100.00 
4,200.00 


«100.000  00 
50,000.00 
42,000.00 
6,300.00 


?1^5^3oo^   ITMliooToo 


48 


t^l^^JTllZ:^""''''  ^^--  ^-'  ^--  'y  -^-^ '- 


QUESTIONS  AND  PROBLEMS 

XYZ  COMPANY 

Balance  Sheet 
December  31,  1921 

— -♦ ' 

Assets 

Real  Estate,  Buildings,  Plants,  Machinery,  Equipment, 
and  other  Permanent  Investments,  including  Good- will. 
Investment  in  Stocks  and  Bonds  at  cost  (Market  value! 
$60,000.00), 
Current  Assets: 
Inventories: 

Raw  Materials,  $170,000.00 

Finished  Product,  at  sales  price,  less  5  per 


603 


$1,000,000.00 
100,000.00 


cent  discount. 
Consignments  (selling  value), 
Supplies  (estimated). 


100,000.00 

50,000.00 

200,000.00 


$520,000.00 
125,000.00 


Accounts  and  Bills  Receivable,  including 

Advances  to  Employees, 

Stocks  in  the  Treasury  (Unissued) : 

Preferred,  $150,000.00 

Common,  137,225.00    287,225.00 

225,500.00 


Investments  in  Subsidiary  Companies, 
Cash  and  Miscellaneous  Items, 


50,50000      1,208,225  00 
$2,308,225.00 


Liabilities 


Capital  Stock: 
Preferred, 
Common, 

Bonds  and  Bankers '  Loans  (Bonds  outstanding  $200,000.00), 
Current  Liabilities: 

Accounts  Payable, 

Other  Indebtedness, 

Accrued  Items, 
Reserves: 

For  Depreciation, 

Less — Renewal  Expenditures  Written  oflF, 

Balance  (Debit), 

For  Bad  Debts, 

For  Contingencies, 
Surplus   (less  dividends  paid),   including  Appre- 
ciation  in  Real  Estate  and  other  Capital  Assets 
and   Profit  on  Inventorying   Raw   Materials  at 
market  price. 


$500,000.00 
750,000.00 
575,000.00 


$  15,225.00 

231,000.00 

2,000.00 

$  50,000.00 
65,000.00 

$  15,000.00 
20,000.00 
5,000.00 


248,225.00 


10,000.00 


225,000.00 


$2,308,225.00 


604 


ADVANCED  ACCOUNTING 

49 


From  the  following  figures  of  net  sales,  costs  and  expenses  prepare  a 
statement,  accounting  for  the  shrinkage  in  profits  in  1920,  and  showing  in 
dollars  and  cents  what  portion  of  such  shrinkage  is  due  to  decreased  sales 
and  what  portion  is  occasioned  by  the  various  variations  in  cost  and  expense 
items: 


Materials, 
Direct  labor, 
Indirect  labor. 
Factory  expenses, 
Trading  expenses, 
Oflfice  expenses, 
Net  Sales, 


1920 

$230,500.00 

78,500.00 

6,725.00 

27,500.00 

23,500.00 

10,50000 

$390,750.00 


1919 

$265,335.00 

108,228.75 

8,379.00 

26,999.00 

20,947.50 

^11,637.50 

i465,500.00 


50 


The  bookkeeper  of  a  manufacturing  concern  could  produce  only  the 
following  statement  from  its  records  on  January  1,  1920: 


$  4,622.89 

10,000.00 

17,500.00 

8,469.10 

15,000.00 

4,289.34 

5,000.00 

5,423.23 

2,436.28 

393.75 

282.40 

832.14 


Manufacturing  expenses. 

Capital  stock. 

Plant  and  equipment. 

Gross  sales, 

First  mortgage  bond  (due  December  31,  1920), 

Materials  and  supplies  (inventory). 

Notes  payable, 

Accounts  receivable. 

Accounts  payable, 

Interest  on  bonds  (seven  months). 

Interest  on  notes  and  accounts  payable, 

Cash, 

On  January  1,  1920,  the  management  changes,  and  you  are  later  retained 
as  a  public  accountant  to  conduct  an  examination  and  prepare  a  balance 
sheet  as  of  January  1,  1921. 

You  find  that  during  the  preceding  year  the  directors  have  subscribed  in 
cash  to  $7,500.00  additional  capital  stock  and  have  retired  all  the  notes  and 
old  accounts  payable  and  that  no  interest  was  paid  on  these  accounts  for 
the  year.  You  also  find  that  the  plant  and  the  equipment  was  revalued 
at  $15,000.00  and  5  per  cent  of  this  amount  was  charged  off  to  provide  for 
depreciation,  while  an  additional  2}4  per  cent  was  ordered  placed  in  reserve 
account  to  cover  repairs  and  renewals,  the  entire  7H  per  cent  being  charged 
direct  to  profit  and  loss.  The  bond  outstanding  feU  due  on  December  31, 
1920,  and  was  paid,  principal  and  interest,  in  cash. 

An  inventory  of  material  and  supplies  placed  their  value  at  $2,328.19, 
the  practice  being  to  charge  aU  purchases  direct  to  manufacturing  expenses 
and  credit  back  the  amount  of  the  inventory. 

The  accounts  payable  (all  for  material  and  non-interest  bearing)  amount 
o  $546.28. 


QUESTIONS  AND  PROBLEMS 


605 


Of  the  accounts  receivable  January  1,  1920,  $4,968.18  was  collected  and 
the  balance  charged  off  as  uncollectible. 

In  addition  to  the  material  used  from  stock  diu-ing  the  year  and  the  amount 
still  due  for  material  purchased,  the  manufacturing  expenses  were  $3,720.52, 
all  paid  in  cash,  the  total  manufacturing  expenses  being  31  per  cent  of  the 
gross  sales  for  the  year  ending  January  1,  1921. 

Of  these  91.3  per  cent  were  collected  in  cash  and  the  balance,  all  of 
which  is  considered  good,  remains  on  the  books  in  accounts  receivable. 

Produce  a  comparative  balance  sheet  of  January  1,  1921-1920,  and  state 
the  amount  of  the  gross  sales  for  the  year. 

QUESTIONS   ON   CHAPTER    XI 

Twenty  Questions,  Five  Problems 

201.  Redraft  the  following  statements,  if  incorrect.     Interest  on  capital 
to  be  5  per  cent  per  annum: 

Balance  Sheet 


Accounts  payable. 

Notes  receivable, 
Capital — partners, 
6/31/19—, 
Net  profit. 


December  31,  19 — 

$  5,400.00    Accounts  receivable, 
3,200.00     Cash, 

Bank  loan, 
10,000.00    Inventory  12/31/1^—, 
8.000.00     Notes  payable, 
$26,600.00 


$10,200.00 
4,700.00 
5,000.00 
5,000.00 
1,700.00 

$26,600.00 


Profit  and  Loss  Statement 
Six  Months  Ended  December  31,  19 — 
Purchases,  $27,000.00     Sales, 

Inventory,  12/31/19—,  5 ,  000 .  00     Interest  on  capital. 


Drawings, 

Rent, 

Salaries, 

Wages, 

General  expenses, 

Interest  on  loan, 

Net  profit, 


2,500.00     Inventory,  7/1/19—, 
500 .  00     Commissions, 

1,500.00 

4,750.00 
900.00 
125.00 

8,000.00 


$40,025.00 

500.00 

8,250.00 

1,500.00 


$50,275.00 


$50,275.00 


202.  a.  In  determining  the  value  of  a  business,   would  you  base  your 

decision  chiefly  upon  the  balance  sheet  or  upon  the  statement  of 
profit  and  loss?  Give  reasons  for  your  answer.  (*) 
b.  What  is  your  interpretation  of  the  difference  between  the  total 
debit  balances  and  the  total  credit  balances  of  the  accounts  belong- 
ing to  the  capital  division  and  to  the  current  division  of  a  balance 
sheet? 

203.  Discuss  "going  value"  in  the  following  case:  A  certain  corporation 
of  a  public  service  nature  with  all  its  property  in  one  state  is  incorpor- 
ated in  another  state.    It  has  outstanding  securities  in  the  amount  of 


606 


ADVANCED  ACCOUNTING 


$40,000,000.00,  while  the  appraised  value  of  its  property  is 
$32,000  000.00.     In  making  application  for  a  charter  in  the  state  in 

to  the  $32,000,000.00  appraised  value  of  its  property  it  has  a  -Roing 
value  of  an  additional  $8,000,000.00,  which  brings  its  total  property 
up  to  the  amount  of  its  outstanding  securities      (*) 

204.  What  is  your  understanding  of  the  foUowing  terms  used  in  connection 
'  with  corporate  accounting:     (*) 

a.  Fixed  charges. 

b.  Maintenance  expenditures. 

c.  Replacement  expenditures. 

205.  a.  A  certain  manufacturing  concern  makes  various  kinds  of  equipment 

for  use  m  its  own  plant  and  charges  them  to  the  fixed  asset  accounts 
at  market  value,  which  is  in  excess  of  cost,  and  credits  the  difference 
to  profit  and  loss  of  the  period  in  which  the  various  equipment  were 
manufactured.  Criticize,  if  necessary.  (*) 
b.  FVom  an  accountant's  point  of  view,  what  are  the  most  important 
things  in  a  balance  sheet?     (*) 

206.  Which  of  the  following  charges  are  proper  additions  to  the  plant 
account:     (*) 

a.  Interest  on  bank  loans,  •j  o<v^  nn 

b.  Salary  of  engineer,  8  000  00 

c.  Legal  and  other  sundry  expenses  incurred  in  acquiring 

certain  properties,  g  ooo  00 

207.  Indicate  the  balance  sheet  set-out  of  the  foUowing  items  as  of  December 

a.  Sinking  fund  assets, 

b.  Unissued  preferred  stock, 

c.  Dividend  payable,   March   15,   1922,   declared  on 
December  20,  1921, 

d.  Reserve  for  bad  debts, 

208.  Indicate  the  balance  sheet  valuation  of  the  following  items:     (♦) 

a.  Outside  investments  held  as  marketable  investments. 

b.  Outside  investments  held  as  permanent  investments. 

209.  a.  In  a  statement  of  the  earnings  of  a  business  te  be  sold  on  the  basis 

of  its  earning  capacity,  how  should  the  question  of  interest  paid  on 
accounts  payable,  on  bills  payable  and  on  loans  be  treated? 
b.  Prepare  a  chart  of  a  balance  sheet,  showing  the  relationship  of  aU 
factors  mvolved  in  its  construction  that  will  exhibit  a  view  of  what, 
m  your  opinion,  is  the  meaning  of  a  balance  sheet. 

210.  In  preparing  an  mcome  statement  for  the  purpose  of  setting  out  the 
earning  power  of  a  business,  how  should  the  foUowing  items  be  treated 
and  why:     (*)  * 

a.  Interest  on  indebtedness,  bank  loans,  bonds,  etc., 

b.  Salaries  of  management, 

c.  Settlement  of  a  patent  suit  extending  over  a  five-year 
period, 

d.  Profit  from  the  sale  of  property, 


$  39,777.43 
100,000.00 

25,000.00 
18,916.34 


$  70,000.00 
120,000.00 


50,000  00 
12,000  00 


QUESTIONS  AND  PROBLEMS 


607 


211.  A  client  submits  to  you  the  foUowing  statement,  covering  a  period  of 
ten  years,  of  a  long-established  nut  and  bolt  business  which  he  con- 
templates purchasing: 

Sales,  averaging  per  year,  $300,000.00 

Wages,  averaging  per  year,  100,000.00 

Expenses,  averaging  per  year,  15,000.00 

M  aterials  used,  115, 000  00 

Real  estate,  appraised  value,  50 ,  000 .  00 

Machinery,  two  years  old,  original  cost,  20,000.00 

Machinery,  four  years  old,  original  cost,  10,000.00 

Machinery,  ten  years  old,  original  cost,  20,000.00 

Materials  on  hand,  40 ,  000 .  00 

From  the  above  figures  write  a  brief  report,  to  submit  to  your  cUent, 
*  setting  forth  the  value  of  the  business,  including  goodwiU. 

Assets 


212. 


Land  and  bmlding, 
Machinery, 
Inventory, 
Accounts  receivable, 
Loans  to  oflBcers, 
Cash, 


1921  1920 

57,000.00     $  60,000  00 


9,000.00 
44,771.00 
26,109.00 
15,000.00 

7,260  00 


10,000.00 
39,321  00 
30,219  00 
10,000.00 
10,600.00 


LiabiUties 


Accounts  payable, 
Notes  payable. 
Capital  stock, 
Surplus, 


$159,140  00  $160,140  00 

$  27,140.00  $  30,140.00 

22,000.00  20,000.00 

100,000.00  100,000  00 

10,000.00  10,000.00 

$159,14000  $160,140.00 

How  much  of  a  loan  would  a  bank  be  justified  in  granting  this  com- 
pany? Give  reasons.  (*) 
213.  Criticize  the  foUowing  profit  and  loss  statement  and  balance  sheet  of  a 
private  firm  trading  in  provisions  from  the  point  of  view  of  a  bank 
which  contemplates  advancing  $20,000.00  to  the  firm.  The  clerical 
accuracy  of  the  books  has  been  verified. 

Statement  of  Profit  and  Loss 


Stock  at  1/1/20, 
Purchases, 
Wages  and  salaries, 
OflSce    and    general 
expense, 
Rent,  ete., 
Interest  on  loans, 
Bad  debts, 
Profits, 


Year  Ended  December  31,  1920 

$50 ,  000 .  00     Sales  less  returns, 
40,000.00     Stock  at  12/31/20, 
8 ,  000 .  00    Dividends  on  investment 


$80,000.00 

75,000.00 

5,500.00 


7,000.00 
15,000.00 

2,700.00 

800.00 

37,000.00 


$160,500.00 


$160,500.00 


608 


Assets 


ADVANCED  ACCOUNTING 

Balance  Sheet 
December  31,  1920 

Liabilities 


$344,500.00 
27,000.00 


Book  debts,  $250,000.00  Trade  creditors, 

Stock  as  per  inven-  Loans, 

tory  75,000.00 

Investments  at  cost,  50 ,  000 .  00  Partners  Capital, 

Good-wiU,  10,000.00  1/1/20,  $  8,000.00 

Lease  of  premises,        5,000.00  Profit,  37,000.00 

Furniture,  etc.,  1,000.00  $45,000.00 

Cash  in  hand,  500.00  Less — Drawings 

during  year,  25,000.00      20,00000 

$301,500  00 


$391,500.00  

214.  a.  Draw  up  a  form  of  balance  sheet  for  a  manufacturing  company 

owning  its  own  plant,  so  as  to  also  show  at  a  glance  the  amount  of 
circulating  (working)  capital  invested, 
b.  What  is  the  mechanism  of  the  double  form  balance  sheet?    Explain 
the   connection  between  its  sections,   stating  the  theory  of  its 
organism. 

215.  In  the  balance  sheet  of  a  company,  as  prepared  by  the  secretary, 
you  find  the  following  items: 

Under  capital  assets: 

a.  Factory  real  estate,  buildings,  plant  and  machinery. 

b.  Real  estate  held  for  investment. 

c.  Investments  in  and  advances  to  another  company  for  purposes  of 
control. 

d.  Franchises  having  a  fixed  term. 
Under  current  assets: 

e.  Company's  treasury  stock  (carried  at  $.50  on  the  dollar). 

f.  Raw  material,  finished  product,  and  inventory  of  oflSce  supplies 
and  stationery. 

g.  Advances  to  oflScials  of  the  company  (unsecured). 

h.  Insurance  premiums  paid  by  the  company  on  a  policy  of  the  life 
of  the  company's  president,  in  which  the  company  is  beneficiary, 
i.    Due  by  customers, 
j.    Sinking  fund  investments, 
k.  Unexpired  fire  insurance  premium. 
1.   Cash  in  bank  and  on  hand. 

Discuss  the  correctness  or  otherwise  of  the  above  classification  of 
items  under  capital  and  current  assets,  giving  reasons  for  your  opinions, 
and  criticizing  the  items  generally. 

216.  a.  Define  the  term  "passive  Uabilities." 

b.  A  distinction  is  made  between  funded  debt  and  unfunded  debt. 
Please  define  and  compare,  discussing  the  advantages  and  disad- 
vantages, if  any,  attaching  to  each.     (A.  I.  A.) 

c.  Give  examples  of  such  aasets  and  liabilities  not  usually  found  on 


QUESTIONS  AND  PROBLEMS 


609 


books  of  account,  as  should  be  considered  by  the  auditor  when 
preparing  an  income  and  profit  and  loss  statement  at  the  close  of 
the  fiscal  period. 

217.  a.  What  do  you  understand  to  be  the  meaning  of  the  word  "deferred" 

when  applied  to  accounts? 

b.  Define: 

1.  Deferred  charges. 

2.  Deferred  credits. 

3.  Contingent  assets. 

c.  Why  is  capital  always  shown  on  a  balance  sheet  as  a  liability? 

218.  a.  Explain  the  treatment  you  would  give  the  following  in  the  books 

of  account. 

b.  State  the  counterbalancing  or  offsetting  accounts. 

c.  Explain  how  they  would  appear  on  the  balance  sheet. 


1.  Notes  receivable  discounted. 

2.  Actions  pending  against  your  chent. 
Cumulative  preferred  dividends  payable. 
Liability  as  guarantor  for  third  parties. 
Liability  as  accommodation  signer  on  note. 
Contingent  liabiUties  under  contract. 

7.  Unpaid  balances  on  contracts  not  yet  fulfilled. 

8.  Collateral  in  possession  of  your  banker  to  secure  payment  of  a  note. 
219.  Draw  up  a  short  report  on  the  following  balance  sheet,  criticizing 

such  items  as  you  consider  abnormal: 


3. 
4. 
6. 
6. 


Buildings, 

Machinery, 

Sundry  stock. 

Cash, 

Bills  receivable, 

Customers, 


$  87 ,  500 .  00    Capital  and  surplus,  $155 ,  000 .  00 


12 ,  500 .  00     Current  habihties, 
90,000.00     Suspense  account, 

3,200.00 

6,800.00 
20,000.00 


87,500.00 
7,5()0.00 


Good-wiU  and  patents,  30.00000 

$250,000.00 


$250,000.00 


220.  A  certain  accountant,  upon  the  basis  of  the  following  figures,  was 
asked  to  explain  the  changes  in  value  which  lead  to  the  bankruptcy 
of  the  Ru-Ja  Manufacturing  Company: 

Values  at  June  30,  1921:  land,  $75,000.00;  buildings,  plant  and  ma- 
chinery, $120,000.00;  new  machinery,  $20,000.00;  good-will,  $20,000.00;^ 
work  in  progress,  $20,000.00;  raw  materials,  $15,000.00;  accounts 
receivable,  $60,000.00;  notes  receivable,  $5,000.00;  cash,  $500.00; 
mortgage  payable,  $25,000.00;  accounts  payable,  $90,000.00;  notes 
payable,  $15,000.00;  advances  on  contracts,  $15,000.00;  wages  accrued, 
$500.00;  taxes  accrued,  $2,000.00;   capital  stock,$200,000.00;  deficit, 

$12,000.00. 

Values  at  June  30,  1920,  were  the  same  as  the  above  with  the  foUowmg 

exceptions:  no   new  machinery;  work  in  progress,  $25,000.00;    raw 


610 


ADVANCED  ACCOUNTING 

$2^^m^-^^^^  ^^'""*'^^'  ^^'^00;  notes  receivable, 

payable,  « 10,000.00;  notes  payable,  $30,000.00;  no  advances  on  con- 

^  '?*^^"'"'"*^'  ^"^  *^^^  ^««^"«d;  capital  stock,  $300  (Sk)  m- 
surplus,  $5,000.00.  (*)  oi-"!^*^,  ♦oiii»,uuu.uu. 


PROBLEMS  ON  CHAPTER    XI 
51 

Examine  and  criticize  the  following  profit  and  loss  statement  of  a  cn^\ 


$215,000.00 
30,000.00 


Sales  of  coal,  250,000  tons, 

Mining  Labor, 

Supplies,  expenses  and  repairs, 

Rents  and  miscellaneous  income, 
Steel  car  earnings,  net  of  repairs^ 

SeUing  ex^nses,  including  agents'  commissions,  $10,000  00 
General  office  expenses,  ^^^^ 

TaxU  ^  ^OO 

Interest  and  discount,  q^ '  ^  ^ 

Net  profit,  ,35,000^ 


$300,000.00 

245,000.00 

$55,000  00 

12,000.00 

20,000  (K) 


$87,000.00 


52,000.00 


$35,000.00 


52 

A  manufactm^r  is  desirous  of  securing  a  partner  and  furnishes  a  state- 
ment  covermg  five  years'  operations  a^  foUows: 

Assets 
Buildings, 
Machinery  and  fixtures, 


Inventory,  merchandise  and  supplies. 
Cash, 

Accounts  receivable. 

Liabilities 
Accounts  and  bills  payable, 
Sales  average  per  year, 
Wages  paid  per  year, 


$20,000.00 

75,000.00 

50,000  00 

5,000.00 

40,000.00 


30,000.00 
500,000.00 
170,000.00 

35,000.00 
260,000.00 


Expense,  selling  and  general,  per  year, 
Material  purchased, 

AW ,  uuu .  uu 

rent^il^m'^'R''^^  ^''""^'  ''"^  '"^'"^  ^'^  "^"^  ^'"^^  ^^^^'^^  land 
rental,  $1,000.00.     Buildings  revert  to  owner  at  expiration  of  lea^. 

New  machinery  when  installed  ten  years  ago  cost  $50,000.00.     Additions 


QUESTIONS  AND  PROBLEMS 


611 


since  cost  $25,000.00.     No  depreciation  has  been  charged  off.     All  repairs 
and  replacements  charged  to  expense. 

What  in  your  opinion  would  be  a  fair  price  to  be  contributed  for  a  half 
interest?    Explain  fully. 

5S 

A  manufacturing  company  that  had  been  in  business  for  a  number  of 
years,  began  operations  the  first  of  a  certain  year  in  an  entirely  new  plant, 
built  to  last  twenty  years,  the  building  of  which  was  made  necessary  by  wear 
and  tear  and  obsolescence  affecting  the  old  plant.  The  new  equipment 
cost  $200,000.00,  for  which  the  company  issued  ten  obligations  of  $20,000.00 
each  at  6  per  cent,  maturing  the  first  of  each  year  following  the  date  of  their 
occupancy  of  the  new  plant.  The  old  plant  has  been  disposed  of  at  a 
scrap  value  of  $10,000.00,  when  it  was  vacated,  at  which  time  the  balance 
sheet  of  the  company  sh.wed: 

Assets 
Plant,  $225,000.00 

Less  scrap  value,  10,00000    $215 ,  000  00 

Other  assets,  80,00000 

$295,000  00 

■■  ■  r 

$200,000  00 
50,000  00 
25,000.00 

20,000.00 
$295,000  00 

The  new  plant  was  at  once  added  to  the  asset  values  at  $200,000.00, 
and  the  company's  liability  on  its  obligations  shown  for  the  same  amount. 

Owing  to  competition  and  limited  use  of  products,  the  sales  have  been 
uniform  for  a  number  of  years,  and  could  not  be  expected  to  increase,  but 
the  new  and  improved  machinery,  with  better  methods  of  manufacture, 
saves  10  per  cent  in  operating  expenses  (including  therein  6  per  cent  interest 
on  the  borrowed  money)  by  their  method  of  accounting. 

The  books  have  shown  a  net  earning  of  $25,000.00  per  year,  as  follows: 


Liabilities 


Capital  stock, 
Surplus, 
Profit  and  loss. 
Gross  sales  for  year. 
Less  operating  expenses, 
Floating  debt. 


$100,000.00 
75,000.00 


Gross  sales. 
Operating  expenses: 

Manufacturing  expenses 

Repairs  expenses. 

Selling  expenses. 

General  expenses, 

Taxes  expenses. 

Insurance  expenses. 

Ground  lease  rentals, 
Net, 


$100,000.00 


75,000.00 


$25,000.00 


612 


ADVANCED  ACCOUNTING 


At  the  close  of  the  first  year's  operations  of 
sheet  showed  as  follows: 

Assets 
Plant,  ' 

Other  assets, 


Capital  stock, 
Surplus, 
Profit  and  loss, 
Sales  for  the  year. 
Less  operating  expenses, 
Notes  payable. 
Floating  debt, 


Liabilities 


the  new  plant,  the  balance 


•415,000.00 

112,50000 

I527,5()0.00 

1200,000.00 
75,000.00 
32,500.00 


1100,000.00 
67,500.00 


200,000.00 
20,000.00 
$527,500.00 

The  balance  sheet  is  submitted,  and  a  dividend  declared.  Discuss  aU 
the  foregoing,  and  illustrate  your  conclusions,  and  draw  up  statement 
showing  what,  in  your  opinion,  is  the  true  condition  of  the  comi)any. 

54 

The  balance  sheets  of  the  Greenleaf  Manufacturing  Company  at  Decem- 
ber 31,  1913,  and  December  31,  1914,  may  be  summarized  as  follows: 


Good-will, 

Land  and  buildings. 

Machinery, 

Tools, 

Unexpired  insurance. 

Inventories, 

Accounts  receivable. 

Cash, 

Investments  in  stocks  and  bonds, 

Capital  stock, 

Bonds, 

Bank  and  other  loans, 

Accounts  payable. 

Accrued  interest. 

Accrued  taxes. 

Surplus, 


Dec.  31,  1913 

I    200,000.00 

450,000.00 

200,000.00 

40,000.00 

3,000.00 

400,000.00 

175,000.00 

25,000.00 

95,000.00     

$1,588,000.00    $2,109,00000 


Dec.  31,  1914 

$    230,000.00 

760,000.00 

400,000.00 

80,000.00 

4,000.00 

375,000.00 

250,000  00 

20,000.00 


$1,100,000.00 

500,000  00 

80,000.00 

125,000  00 

11,000  00 

6,000  00 

287,000  00 

$1,588,000  00    $2,109,000^00 

During  the  year  a  dividend  of  4  per  cent  was  declared  and  paid  on  the  stock 
outstanding  at  the  beginning  of  the  year.  $7,000.00  was  provided  for  the 
depreciation  of  the  buildings,  $16,000.00  for  machinery,  and  $4,000.00  for 
tools.  The  bonds  were  sold  for  par,  and  the  stock  was  sold  at  90  and  the 
difference  was  charged  to  good-will  account. 


800,000.00 

350,000.00 

70,000.00 

145,000.00 

7,000.00 

4,000.00 

212,000.00 


QUESTIONS  AND  PROBLEMS 


613 


In  the  light  of  the  above  facts  interpret  the  changes  that  have  taken  place 
in  the  financial  position  of  the  company  between  the  two  dates,  and,  so  far 
as  possible,  indicate  how  they  were  effected. 

55 

From  the  following  comparative  balance  sheets  of  the  A.  B.  C.  Company 
at  December  31,  1917,  and  December  31,  1918,  prepare  a  short  statement 
showing  the  funds  realized  during  the  year  and  the  disposition  made  thereof: 

Dec.  31,  1917       Dec.  31,  1918 

$  600,000.00  $  900,000.00 


1,000,000.00 

850,000.00 

200,000.00 

20,000.00 


1,160,000.00 

800,000.00 

550,000.00 

10,000.00 


$2,670,000.00    $3,420,00000 

$1,000,000.00    $1,000,000.00 

500,000.00 


750,000.00 
500,000.00 
100,000.00 


150,000.00 
400,000.00 
600,000.00 
200,000.00 


Assets 

Capital  assets, 

(Replacement  values  as  shown  by  ap- 
praisal were  used  at  December  31, 1918.) 
Inventories, 
Accounts  receivable. 
Cash, 
Deferred  charges, 

LiabilitJCT 

Capital  stock. 
Bonds  (issued  at  par). 
Capital  surplus  representing  excess  of  sound 
replacement  value  of  appraisal  at  Decem- 
ber 31, 1918,  over  the  book  value  of  capital 
assets  at  that  date. 
Bank  loans. 
Accounts  payable. 

Reserve  for  depreciation  and  replacements, 
(The  reserve  at  December  31,  1918,  repre- 
sents the  difference  between  the  replace- 
ment and  sound  value  of  the  appraisal 
at  December  31,  1918.) 
Surplus, 

$2,670,000.00   $3,420,000.00 

Note.  The  profits  for  the  year  were  $450,000.00,  and  dividends  were  paid 
during  the  year  amounting  to  $200,000.00.  The  sum  of  $100,000.00  was 
charged  to  operation  for  depreciation  during  the  year  and  $50,000.00  was 
charged  against  the  reserve  for  replacements.    (A.  I.  A.) 

QUESTIONS  ON  CHAPTER  XH 

Twenty  Questions,  Five  Problems 

221.  a.  Define  merger. 

b.  Define  amalgamation. 

222.  The  A  Company  acquired  the  entire  capital  stock  of  the  B  Company 
by  purchase  and  claimed  to  have  absorbed  subsequently  the  B  Com- 
pany by  merger,  and  as  an  evidence  thereof,  recorded  on  its  own  books 
of  account,  the  varous  assets  and  liabilities  of  the  B  Company.    How 


320,000.00         670,000.00 


614 


ADVANCED  ACCOUNTING 


would  you,  as  auditor,  proceed  to  satisfy  yourself  that  such  traas- 
actions  were  correct  and  duly  authorized?  How  should  the  account 
on  the  books  of  the  A  Company,  representing  the  capital  stock  of  the 
B  Company,  be  disposed  of? 

223.  If  a  New  York  corporation  was  merged,  at  some  date  other  than  the 
end  of  the  fiscal  year,  into  another  New  York  corporation  which 
owned  all  of  the  outstanding  stock  of  the  first  corporation,  how  would 
you  handle  the  existing  accounts  of  the  two  corporations,  as  of  the  date 
when  the  merger  became  effective,  and  subsequent  thereto? 

224.  A  and  company  acquire  the  plants  of  B,  C,  D,  and  E,  assuming  their 
assets  and  liabilities  at  book  values,  the  purchase  price  being  one-half 
of  the  amount  shown  by  the  surplus  account  of  each.  Without  going 
into  lengthy  detail,  but  just  considering  the  three  items,  assets, 
liabilities,  and  surplus,  what  entries  would  you  make  to  set  up  these 
accounts  in  the  ledger  of  A  and  company? 

225.  The  A  corporation  to  prevent  injurious  competition  purchases  from 
the  B  corporation,  a  competing  firm,  the  whole  of  its  business  as  a 
going  concern  on  January  1,  1920.  for  $500,000.00,  subject,  however, 
to  certain  conditions  stated  below. 

The  B  corporation  agrees  to  continue  trading  under  its  old  management 
on  behalf  of  and  at  the  expense  of  the  A  corporation  until  December 
31,  1920,  when  if  the  profits  earned  amount  to  less  than  $40,000.00, 
the  A  corporation  reserves  to  itself  the  right  to  cancel  the  agreement 
for  purchase  on  payment  of  the  difference  between  the  earnings  for 
the  year  and  $40,000.00. 

At  December  31,  1920,  the  profits  for  the  year  earned  by  the  B  cor- 
poration amount  to  $50,000.00,  and  the  A  corporation  actually  takes 
over  the  B  corporation,  paying  $450,000.00  in  full  settlement. 
Criticize  the  following  methods  of  treating  the  transaction,  and  state 
which  you  consider  correct,  giving  reasons  for  your  opinion: 

a.  Debit  investment  account  with  $500,000.00  and  credit  profit  and 
loss  with  $50,000.00  earnings. 

b.  Debit  investment  account  with  $450,000.00. 

c.  Debit  investment  account  with  $500,000.00  and  credit  special  re- 
serve account  with  $50,000.00. 

It  may  be  taken  as  an  ascertained  fact  that  the  assets  are  fully  worth 
$500,000.00  at  the  time  of  purchase  by  the  A  corporation. 
226.  A  mining  company  purchases  the  assets  of  another  company,  subject 
to  its  Uabilities,  for  $1,000,000.00.     It  opens  up  books,  transcribing 
the  balance  sheet  of  the  old  company  as  below: 


Assets: 
Cash, 

Accounts  receivable, 
Ore  on  dump, 
Mine, 


t         347.60 

14,200.26 

5,807.00 

700,428.00 


$720,782.86 


I 


QUESTIONS  AND  PROBLEMS 


Liabilities: 
Bank  loans, 
Accounts  payable, 
Capital, 
Surplus, 


615 


$  32,500.00 

28,370.40 

500,000.00 

159,912.45 

$720,782.85 


An  entry  is  made  debiting  mine  and  crediting  capital  account  for 
$500,000.00  thereby  increasing  the  latter  account  to  $1,000,000.00, 
the  purchase  price.  If  you  find  anything  to  criticize  here,  write  a  short 
report  to  the  directors,  stating  your  objections,  your  reasons  therefor, 
and  the  proper  entries  to  make  the  necessary  corrections.     (*) 

227.  What  are  the  essential  features  to  be  considered  when  two  or  more 
companies  contemplate  consolidation? 

228.  Give  sample  of  a  report  such  as  you  would  make  after  having  examined 
several  copartnerships  engaged  in  the  same  line  of  business,  that 
desire  to  combine  in  one  corporation.  Give  your  views  and  reasons 
therefor  as  to  the  advisability  or  as  to  the  inadvisability  of  the  merger. 

229.  Under  what  circumstances  is  it  necessary  to  open  a  good- will  account? 
What  advantages  are  there  in  allowing  it  to  remain  open  indefinitely 
on  the  books?  If  the  tangible  assets  taken  over  by  a  company  are  in 
excess  of  the  capital  stock,  would  you  credit  the  excess  to  surplus? 
If  not,  why  not,  and  to  what  account  would  you  credit  such  excess? 

230.  In  the  case  of  the  consolidation  of  three  manufacturing  concerns,  how 
would  you  determine  the  amount  of  good-will  of  the  consolidated 
company? 

231.  A  manufacturing  corporation  desires  a  certificate  of  its  average  annual 
profits  for  three  years;  after  charging  up  all  costs,  expenses,  and  de- 
preciation, and  an  allowance  for  bad  debts,  it  is  found  that  the  profits 
for  the  first  year  were  $62,000.00,  for  the  second  year  $64,000.00 
plus  $10,500.00  profit  on  sale  of  investments,  and  for  the  third  year 
$72,000.00  plus  $8,400.00  profit  on  the  sale  of  real  estate.  Give  the 
average  annual  profit  to  be  certified. 

232.  In  a  statement  of  the  earnings  of  a  business  to  be  sold  on  the  basis 
of  its  earning  capacity,  how  should  the  question  of  interest  paid  on 
accounts  payable,  on  bills  payable  and  on  loans  be  treated? 

233.  Where  a  number  of  manufacturers  contemplate  consolidating,  what 
means  should  be  taken  to  insure  the  statements  of  assets  and  lia- 
bilities and  profits  being  on  the  same  general  plan? 

234.  Three  corporations  are  to  be  merged.  In  examining  the  records  of 
corporation  B,  formed  three  years  previously  with  an  authorized 
capitalization  of  $250,000.00,  you  find  the  entire  capital  stock  on  the 
books  as  fully  paid  in.  The  facts  you  ascertain  are  as  follows: 
There  are  three  directors,  X,  Y,  and  Z,  composing  all  the  subscribers 
to  the  stock.  The  payments  have  been  received  at  a  directors' 
meeting  with  all  present.  X  subscribed  for  $100,000.00  worth  of  stock 
and  paid  all  in  cash;  Y  subscribed  for  $75,000.00  worth  of  stock  and 
paid  $50,000.00  in  cash  and  a  note  of  $25,000.00  on  demand;    Z  sub- 


I 


616 


ADVANCED  ACCOUNTINO 


scribed  for  $75,000.00  worth  of  stock  and  paid  $25,000.00  in  cash  and 
a  note  of  $50,000.00  on  demand. 

These  notes  are  carried  among  the  a^ets  and  are  stiU  unpaid  at  the 
time  of  your  examination,  no  interest  having  been  coUected.  Y  and 
Z  cannot  make  good.  In  preparing  a  report  on  this  state  of  facts,  what 
recommendations  would  you  make,  and  why? 

235.  Two  concerns  in  similar  Unes  contemplate  consolidating  their  business. 
You  are  requested  to  examine  the  books  of  account  and  report  on 
matters  germane  to  the  contemplated  merger.    What  data  would  you 
probably  present  in  your  report? 

236.  Your  advice  has  been  asked  as  to  the  basis  of  consolidation  and  recom- 
menations  as  to  the  determination  of  the  value  of  the  physical  assets 
of  the  several  companies.  State  what  your  suggestions  along  these 
lines  would  be,  and  in  your  recommendations  as  to  the  basis  of  con- 
solidation what  weight  would  you  place  upon  the  values  of  the  several 
physical  properties,  the  net  current  assets  owned,  the  volume  of 
business  performed  by  each  company,  and  the  percentage  of  net 
earnings  on  investment? 

237.  An  amalgamation  of  four  manufacturing  corporations  is  proposed. 
You  are  asked  to  give  a  report  as  to  the  earning  power  of  each  company 
for  the  past  ten  years.  What  items  regularly  treated  as  expenses  may 
be  omitted  in  the  preparation  of  your  report?  List  the  items  and  give 
brief  reasons  for  so  doing. 

238.  In  a  report  upon  the  proposed  amalgamation  of  two  companies,  state 
how  you  would  treat  the  foUowing  points  in  arriving  at  the  earning 
power  of  each  concern.     Give  reasons  for  your  treatment: 

a.  Anticipated  profits  on  construction  in  process. 

b.  Depreciation,   repairs,   renewals  and  replacements  of  plant  and 
equipment. 

c.  Interest  paid  on  borrowed  capital. 

d.  Bad  debts  reserve. 

239.  On  March  1,  1913,  two  corporations,  A  and  B,  agreed  to  amalgamate 
on  April  1,  1913,  in  a  new  corporation  C.  The  distribution  of  the 
capital  stock  of  C  to  be  based  upon  the  respective  financial  condition 
of  A  and  B,  on  January  1,  1913,  whereby  A  was  to  receive  40  per  cent 
and  B  60  per  cent  of  said  stock.  AU  assets  of  A  and  B  to  be  turned  over 
to  C,  which  is  to  assume  A's  and  B's  liabilities,  all  as  of  April  1, 
with  adjustment  of  any  dividends  paid  by  A  or  B  between  January  1 
and  that  date.  February  1,  A  had  drawn  out  in  dividends  $20,000.00. 
What  amount  should  B  draw  out  before  the  amalgamation  to  equalize 
the  cash  assets  to  be  turned  over  by  him  to  C? 

240.  The  following  are  the  balance  sheets  of  two  companies  which,  carrying 
on  similar  businesses,  have  decided  to  amalgamate  on  the  basis  that 
the  good-will  and  assets  (except  the  shares  of  Y.  Z.  Mining  Company 
held  by  A.  B.  Minmg  Company)  are  of  equal  value.  How  would  you 
recommend  that  the  amalgamation  should  be  effected? 
State  two  possible  methods,  with  full  explanation  of  your  reasons,  and 
give  in  each  case  the  balance  sheet  of  the  amalgamated  company. 


QUESTIONS  AND  PROBLEMS 


617 


THE  A.  B.  MINING  COMPANY 
Balance  Sheet  at  December  31,  1920 


Assets 


Liabilities 


Cost   of   mines   and  Accounts  payable,         $  12,500.00 

other  assets,          $250,000.00  Creditors  for   cost  of 

Shares  in  the  Y.  Z.  1,250  shares  of  Y.  Z. 

Co.  (1,250 at $100.00  Co.,                              187,500.00 

each)  costing,           187,500.00  Capital  stock,  2,500 

Accounts  receivable,       5 ,  000 .  00  shares  of  $100  each,    250 ,  000 .  00 

Cash,  2,500.00 


Stock  of  minerals. 


5,000.00 
$450,000.00 


$450,000.00 


THE  Y.  Z.  MINING  COMPANY 


Balance  Sheet  at  December  31,  1920 


Assets 


Liabilities 


Cost  of  mines  and  Accounts  payble,             $  10,000.00 

other  assets,        $250 ,  000 .  00  Capital  stock,  2,500  shares 

Stock  of  minerals,       2 ,  500 .  00  of  $  100  each,                  250 ,  000 .  00 
Accounts  receivable,    5 ,  000 .  00 
Cash,                             2,500.00 


$260,000.00 


$260,000.00 


I 


PROBLEMS  ON  CHAPTER  XH 

56 

The  Kent  Wire  Screen  Company  having  acquired  all  of  the  capital  stock 
of  the  Derby  Wire  Netting  Company,  it  is  proposed  to  merge  the  latter  with 
the  former  as  of  July  1,  1912. 

The  trial  balances  June  30,  1912,  of  the  respective  companies  after  closing, 
are  as  follows: 

KENT  WIRE  SCREEN  COMPANY 

Land'and  buildings,  $525,750.00;  equipment,  $85,729.43.00;  motor  trucks, 
$8,780.25;  furniture  and  fixtures,  $6,943.27;  Derby  Wire  Netting  Company, 
capital  stock,  par  value,  $100,000.00,  cost  $97,713.50;  materials  and  supplies, 
$18,379.51;  goods  in  process,  $16,591.46;  finished  goods,  $23,468.46;  cash, 
$12,640.31;  accounts  receivable,  $54,345.26;  notes  receivable  and  interest, 
$10,132.75;  sinking  fund,  $45,376.59;  deferred  charges  to  expense,  $1,537.82; 
first  mortgage  6  per  cent  gold  bonds  payable,  due  1927,  $250,000;  taxes 
accrued,  $5,250.00;  salaries  and  wages  acrrued,  $3,178.29;  accounts  payable, 
$85,216.04;  due  to  Derby  Wire  Netting  Company,  $536.12;  notes  payable 
and  jnterest,  $41,273.25;  interest  accrued  on  bonds  payable,  $2,500.00; 
reserve  for  depreciation  of  plant  and  equipment,  $69,434.91;  preferred 
capital  stock  outstanding,  $250,000.00;  common  capital  stock  outstanding, 
$150,000.00;    profit  and  loss  surplus,  $50,000.00. 


618 


ADVANCED  ACCOUNTING 
DERBY  WIRE  NETTING  COMPANY 


Land  and  buildings,  1240,327.92;  machinery  and  tools,  $48,934  27- 
horses,  wagons,  and  harness,  $6,387.35;  furniture  and  fixtures,  $8,500.0o' 
capital  stock  of  the  Improved  Screen  Door  Company,  par  $20  000  00  cost 
$23,457.86;  patents,  $10,aK).00;  raw  materials,  $23,721.89;  goods  in  process 
$32,568.34;  finished  goods,  $18,478.27;  cash,  $14,686.43;  accounts  re^ 
ceivable,  $57,395.05;  due  from  the  Kent  Wire  Screen  Company,  $536  12- 
notes  receivable  and  interest,  $8,037.50;  sinking  fund,  $30,483.14;  con- 
signment, $1,000.00;  deferred  charges  to  operations,  $1,250.00;  first  mortgage 
5  per  cent  gold  bonds  payable, due  1930, $100,000.00;  taxes  accrued,  $2,787  00- 
salaries  and  wages  accrued,  $5,843.62;  accounts  payable,  $1 14,527. 16  •  due  the 
Improved  Screen  Door  Company,  $10,000.00;  notes  payable  and 'interest, 
$51,673.53;  interest  accrued  on  first  mortgage  Iwnds,  $833.33;  reserve  for 
sinking  fund,  $30,483.14;  reserve  for  depreciation  of  plant  and  equipment 
$37,329.52;  common  capital  stock  outstanding,  $100,000.00;  profit  and  los^ 
surplus,  $72,286.84. 

From  the  foregoing  submit: 

a.  The  entries  on  the  books  of  the  Kent  Wire  Screen  Company  neces- 
sary to  effect  the  merger. 

b.  The  necessary  entries  on  the  books  of  the  Derby  Wire  Netting 
Company. 

c.  Balance  sheet  of  the  Kent  Wire  Screen  Company  after  the  tnenrer 

(*) 

57 

A  close  corporation,  incorporated  under  the  laws  of  the  State  of  lUinois 
known  as  Company  A,  purchases  the  entire  outstanding  capital  stock  of 
$35,000.00  of  Company  B  in  the  year  1920  for  the  sum  of  $52,500.00     A 
statement  of  assets  and  liabilities  as  on  January  1,  1921,  of  each  company  is 
given  below: 

Company  A 
Assets: 

Plant,  machinery,  etc., 

Merchandise, 

Investment  in  Company  B  's  capital  stock, 

Due  by  Company  B  on  current  account, 

Accounts  receivable, 

Cash, 


Liabilities: 
Capital  stock, 
Surplus, 
Accounts  payable, 


I  457.500.00 
400,000.00 
52,500.00 
220,000.00 
400,000.00 
j5,000.00 

$1,575, 000  00 


$1,000,000  00 
500,000.00 
_75,000.00 

$1,575,(X)0.00 


QUESTIONS  AND  PROBLEMS 


619 


Company  B 


Assets: 
Plant,  machinery,  etc., 
Merchandise, 

Unsubscribed  capital  stock, 
Accounts  receivable, 
Cash, 

Liabilities: 
Capital  stock. 
Surplus, 
Due  to  Company  A, 


$  100,000.00 
95,000.00 
65,000.00 
80,000.00 
15,000.00 

$  355,000  00 

$  100,000.00 

35,000.00 

220,00000 

$  355,000  00 


The  directors  of  Company  A,  realizing  that  it  is  illegal  for  an  Illinois  cor- 
poration to  own  the  capital  stock  of  another  corporation,  and  furthermore 
desiring  to  eliminate  the  indebtedness  of  $220,000.00  due  by  Company  B  to 
Company  A  determine  to  sell  the  stock  that  they  own  in  Company  B  to  their 
own  shareholders  at  150.  Company  B  increases  its  capital  stock  from 
$100,000.00  to  $300,000.00,  declares  a  stock  dividend  of  35  per  cent  and  sells 
2,300  shares  (shares  $100.00  each)  to  the  stockholders  of  Company  A  at  par. 
Company  A  declares  and  pays  a  dividend  of  28^  per  cent  to  its  shareholders. 
Company  B  then  liquidates  its  indebtedness  to  Company  A. 

Prepare  journal  and  cash  book  entries  that  each  company  should  make  to 
record  the  above  transactions,  with  suitable  explanations,  and  prepare 
balance  sheet  of  each  corporation  after  completion  of  the  above  trans- 
actions. 

In  this  question  it  is  assumed  that  the  shareholders  in  Company  A  buy 
the  stock  of  Company  B  in  the  same  ratio  as  their  holdings  in  the  stock  of 
Company  A  bears  to  one  another. 


The  Smith  Brewing  Company  with  $1,000,000.00  capital  stock,  the  Young 
Brewing  Company  with  $500,000.00  capital  stock  and  the  Star  Brewing 
Company  with  $400,000.00  capital  stock,  agree  to  consolidate  as  the  Um"- 
versal  Brewing  Corporation,  the  new  company  to  buy  all  the  properties  of 
the  old  companies,  at  a  valuation  to  be  fixed  by  appraisal,  payment  therefor 
to  be  made  in  full-paid  stock  of  the  new  company,  the  old  companies  to 
pay  off  their  own  indebtedness. 

The  appraised  values  of  the  old  companies  are  as  follows: 


Real  Estate 
and 
Buildings 


Plant 


Bills 
Cash         Receivable 


Smith, 

Young, 

Star, 


$680,000.00  $390,000  00  $15,000.00  $10,000.00 
327,000.00  160,000  00  3,000.00  6,000.00 
126,000.00        71,000.00        1,000.00 


h 


620 


1 1  iij 
ij  ■ 


ADVANCED  ACCOUNTING 


Office 

Horees,  Wagons,  and  Harness    Furniture 

Smith,  4,000.00 

Y°"OK»  3,000.00 

S**""'  1,500.00 

Total  appraised  value. 


Total 

1,000.00  $1,100,00000 

1,000.00  500,000  00 

500.00     20(n000  00 

r.    xu-        1       .                                                                '  ll,8fH).000  00 

of  ?t'o  k'^Zr^O^  m^^  Corporation  issued  $2,000,000.00 

01  stock  shares  $100.00  each,  which  was  dividod  pro  rata  amonir  the  old 
compares  on  the  ba.is  of  their  appraised  value,  no  fractional  sWs  of  stock 
to  be  issued,  odd  amounts  to  be  paid  old  companies  in  cash. 

oidciZL?wrh';r'''''"T  '^  ^^^  "^  p^^*^^^  ^^^^^-^^  -^^  --^it 

Old  compames  with  their  pro  rata  on  the  books  of  the  new  company. 
wet\LtlWs  ^^'^^^"^^^^^'^  *^«  '«^^-  ~ts  of  the  Star  Brewery 

Capital  Stock, 
$250,000.00 

247,000.00 

1,000.00     Bills  Payable, 


Real  Estate  and 

Buildings, 
Plant, 
Cash, 
Horses,  Wagons  and 

Harness, 
Office  Furniture, 


1400,000  00 


1,800.00 

__Jj200^    Accounts  Payable, 
$501,000.00 


50,000.00 


51. 000. (to 
$501,000  00 


♦K^  u  I  .  ^T^'  ^''""''^^  ^""^^^^  *^  Hquidate  in  stock  of  the  new  company 
the  liabilities  other  than  capital  stock,  to  apportion  the  remaining  stock  and 
cash,  and  to  close  the  books  of  the  Star  Brewing  Company. 

59 

The  Martin  Manufacturing  Company,  the  U.  S.  Specialty  Company 
and  the  firm  of  Brown  &  Smith  (a  partnership)  decide  to  consohdate  under 
the  name  of  the  Progressive  Manufacturing  Company,  with  an  authorized 
capital  stock  of  $1,300,000,  divided  between  7  per  cent  cumulative  preferred 
stock  of  $500,000,  and  common  stock  of  $800,000.'  ^^.^^ 

Under  the  agreement  of  purchase,  the  vendors  ?eceive  preferred  stock 
at  par  for  the  net  tangible  assets  and  common  stock  for  the  good-will  The 
issue  of  the  common  stock  is  to  be  based  upon  a  sum  equal  to  ten  times  the 
average  annual  earnings  of  the  past  five  years,  after  aUowing  7  per  cent  inter- 
est on  the  capital  invested.  The  foUowing  balance  sheets  reflect  the  financial 
position  of  the  respective  interests  at  the  date  of  the  consohdation. 
Brown  &  Smith  share  profits  and  losses  equaUy. 

Martin  U.  S.  B  A  S 

$102,000.00    $145,000.00    $  95,500.00 
62,400.00         78,500.00         38,700.QP 
61,500.00 
1,700.00 


Plant  and  equipment, 
Accounts  and  notes  receivable. 
Inventory, 
Insurance  unexpired. 
Discount  paid  in  advance, 
Cash, 


48,500.00 
1,250.00 
500.00 
5,600.00 


43, 650. 00 
800.00 


7>250.00  8,650.00 


$220,250  00    $293,950.00    $187,300  00 


QUESTIONS  AND  PROBLEMS 


621 


$100,000.00    $150,000.00 


36,100.00 

750.00 

1,400.00 

82,000.00 


86,075.00 

850.00 

825.00 

2,200.00 

54,000.00 


$72,000.00 

42,000.00 

70,230.00 

1,220  00 

600.00 

1,250.00 


$220,250  00     $293,950.00     $187,300.00 


Capital  stock, 

Brown  capital  account. 

Smith  capital  account. 

Accounts  and  notes  payable, 

Interest  accrued, 

Taxes  accrued. 

Labor  unpaid, 

Surplus, 

Yearly  Earnings 

First  year. 
Second  year, 
Third  year. 
Fourth  year, 
Fifth  year. 

Total, 

Prepare  the  following: 

1.  Opening  journal  entries  on  the  books  of  the  Progressive  Manufacturing 
Company. 

2.  Balance  sheet  after  giving  effect  to  entries  referred  to  in  (1). 

3.  Necessary  journal  entries  to  close  the  books  of  the  respective  vendors. 

60 

The  Excelsior  Gas  Company  is  incorporated  on  January  1,  1920,  with 
an  authorized  capital  of  $300,000.00  (%  preferred  [and  }i  common,  all  the 
shares  being  of  the  par  value  of  $100.00)  to  acquire  and  conduct  the  business 
of  the  Bradford  Gas  Company,  whose  general  balance  sheet  shows  the  follow- 
ing on  December  31,  1919: 


$37,500.00 
48,700.00 
43,400.00 
36,200.00 
59,200.00 


$42,700.00 
31,800.00 
39,600.00 
46,100.00 
39,800.00 


$33,400.00 
26,900.00 
27,350.00 
31,600.00 
30,750.00 


$225,000.00     $200,000.00    $150,000.00 


Buildings,  machinery 
and  equipment, 


Mains,  conduits,  meters 
and  connections, 

Franchises,  rights,  privi- 
leges, etc.. 

Materials  and  supplies, 

Tools  and  emergency 
equipment. 

Cash, 

Accounts  receivable, 


Notes  payable, 
$100 ,  000 .  00    Accounts  payable, 


Capital  stock, 
70,000.00    Surplus, 

50,000.00 
15,000.00 

10,000.00 
11,800.00 
35,200.00 


I  10,000.00 
52,000.00 

200,000.00 
30,000.00 


$292,000.00 


$292,000.00 


On  January  15,  1920,  all  the  preferred  and  common  stock  of  the  Excelsior 
Gas  Company  was  issued  to  the  twenty  stockholders  of  the  Bradford  Gas 
Company,  in  exchange  for  their  holdings  of  stock  of  the  latter  company,  in 
the  proportion  of  one  share  of  preferred  and  one  share  of  common  for  each 
share  of  stock  exchanged. 

At  a  meeting  of  the  board  of  directors  of  the  Excelsior  Gas  Company, 


\i^ 


622 


ADVANCED  ACCOUNTING 


held  January  20,  1920,  it  was  resolved  to  carry  out  the  provisions  of  a  plan 
of  merger  in  accordance  with  which  the  Bradford  Gas  Company  was  to 
transfer  its  assets  and  liabilities  to  the  Excelsior  Gas  Company,  and  sur- 
render its  charter.  A  certificate  of  merger  wa*  issued  at  the  cloae  of  the 
meeting. 

At  the  meeting  held  January  31,  1920,  the  board  of  directors  of  the 
Excelsior  Gas  Company  resolved  to  open  accounts  on  the  general  books  of 
the  company,  with  the  individual  assets  and  liabilities  taken  over  and 
assumed,  at  the  figure  shown  by  the  balance  sheet  of  the  Bradford  Gas 
Company  on  December  31,  1919,  with  the  following  exceptions:  (a)  fran- 
chises, etc.,  to  be  raised  to  $70,000.00;  (b)  surplus  not  to  be  carried. 

As  to  the  January  op)erating  transactions,  they  were  recorded  in  special 
books,  in  order  that  they  might  be  embodied  at  the  proper  time  in  the  books 
of  the  Excelsior  Gas  Company. 

Prepare: 

a.  Chronologic  journal  entries  reflecting  on  the  books  of  the  Excelsior 
Gas  Company  the  dififerent  stages  of  the  merger. 

b.  A  journal  entry  closing  the  books  of  the  Bradford  Gas  Company. 

QUESTIONS   ON   CHAPTER    XIH 

Twenty  Questions,  Five  Problems 

241.  Define  the  following: 

a.  Holding  company. 

b.  Subsidiary  company  (A.  I.  A.) 

c.  Consolidated  balance  sheet. 

d.  Intercompany  profits.     (*) 

242.  Explain  the  theory  and  practical  use  of  a  consolidated  balance  sheet. 

243.  Upon  what  basis  should  the  outstanding  stock  of  subsidiary  companies 
be  taken  in  a  consolidated  balance  sheet? 

244.  a.  When  a  number  of  corporations  are  operating  under  their  own 

charters,  but  are  managed  and  controlled  by  one  other  corporation, 
how  would  you  state  the  results  of  the  business  when  the  controlling 
corporation  owns  all  of  the  stock  of  the  other  corporations? 
b.  How  will  you  handle  on  the  consolidated  balance  sheet  capital  stock 
of  one  of  the  subsidiary  corporations,  part  of  which  is  in  the  hands 
of  the  public? 

245.  In  making  up  a  consolidated  balance  sheet  of  a  holding  or  parent 
company  and  two  subsidiary  companies  where,  in  the  case  of  one  of 
the  subsidiary  companies,  its  entire  capital  stock  has  been  acquired 
at  less  than  par,  and  in  the  case  of  the  other,  at  a  substantial  premium, 
how  would  you  deal  with  such  discount  and  premium,  respectively, 
in  the  consolidated  balance  sheet? 

246.  If  in  consolidating  the  accounts  of  a  holding  company  and  its  subsidiary 
companies,  you  find  that  in  the  case  of  one  of  the  subsidiary  companies 
the  holding  company  owns  only  60%  of  its  voting  stock,  state  briefly 
how  you  would  treat  this  subsidiary  company's  accounts  in  the  con- 
solidated balance  sheet  and  why  your  proposed  treatment  reflects 


QUESTIONS  AND  PROBLEMS 


623 


the  true  financial  position  of  the  combined  companies  more  clearly 
than  other  methods  with  which  you  may  be  familiar.     (A.  I.  A.) 

247.  In  preparing  a  balance  sheet  and  income  account  for  a  holding  com- 
pany, which  embraces  the  operations  of  several  subsidiary  corporations, 
what  items  on  the  subsidiary  books,  if  any,  should  be  omitted  from 
the  consolidated  statements? 

248.  a.  State  briefly  what  you  would  do  if  the  accounts  payable,  amounting 

to  $280,000.00,  include  a  balance  of  $100,000.00  due  to  an  affiliated 
company. 

b.  How  would  you  treat  guarantee  of  payment  of  interest  on  bonds 
issued  by  a  subsidiary  company  in  the  balance  sheet  of  a  company 
j'ou  were  auditing? 

249.  A  parent  company  holding  notes  receivable  from  a  subsidiary  company 
to  the  extent  of  $100,000.00,  indorses  and  discounts  said  notes  with  its 
bankers,  thus  creating  a  contingent  liability  thereunder.  In  preparing 
a  consoUdated  balance  sheet  of  the  two  companies,  state  how  and 
where  the  liability  would  appear. 

250.  The  A  Company  buys  on  January  1,  95  per  cent  of  the  stock  of  the  B 
Company.  The  balance  sheet  of  the  latter  company  on  that  date  is  as 
follows: 


Assets: 

Property  account, 
Current  assets, 

Liabilities: 
Capital, 
Surplus, 
Current  liabilities, 


$  500,000.00 
850,00000 

$1,350,000.00 


$1,000,000.00 
100,000.00 
250,00000 

$1,350,000  00 

The  A  Company  pays  par  for  91  per  cent  of  the  stock  and  120  for 
5  per  cent  of  it.  During  the  next  six  months  a  doubtful  claim  of  the 
B  Company,  which  prior  to  January  1  bad  been  written  off,  turns  out 
to  be  good  and  $5,000.00  cash  is  realized  on  it. 

At  the  end  of  the  first  six  months  B  Company  has  made  $100,000.00 
net  profit  from  operations,  and  a  dividend  of  $200,000.00  is  paid. 
In  making  up  a  consolidated  balance  sheet  of  A  Company  and  its 
subsidiary  at  January  1  (date  of  purchase),  state,  giving  briefly  your 
reasons,  how  you  would  treat: 

a.  A  Company's  interest  in  the  B  Company;  and  at  July  1. 

b.  The  doubtful  claim  recovered. 

c.  The  dividend  paid. 

d.  The  interest  of  outside  B  stockholders  in  B  Company.     (A.  I.  A.) 
251.  Three  corporations  are  consolidated  by  acquiring  all  the  capital  stock 

of  the  said  companies,  with  the  exception  of  10  shares  of  the  smallest 
corporation.  The  new  company  acquires  all  the  assets  and  assumes  all 
the  habilities  of  the  smallest  company  and  closes  its  plant.     How 


i 


■•^:^-^- 


624 


ADVANCED  ACCOUNTING 


should  this  state  of  affairs  be  treated  by  the  accountant  in  opening 
the  books  of  the  new  company? 

252.  A  holding  company  owns  90  per  cent  of  the  capital  stock  of  a  sub- 
sidiary company.  The  directors  of  the  subsidiary  company  pass  a 
resolution  appropriating  surplus  earnings  as  dividends  and  direct  the 
treasurer  to  remit  to  the  holding  company  whenever  sur|)his  funds 
are  available.  The  subsidiary  company  earns  $40,000.00,  which  it  pays 
to  the  holding  company.  What  are  the  rights  of  the  interested 
parties  and  how  should  they  be  set  forth  in  a  brief  report? 

253.  In  the  process  of  consolidating  several  competing  estabhshments, 
Corporation  A,  the  holding  company,  acquires  $98,000.00,  out  of  a 
total  of  $100,000.00,  of  the  capital  stock  of  Company  B.  At  the  time 
of  the  purchase  the  balance  sheet  of  B  Company  showed  surplus 
and  undivided  profits  of  $50,000.00.  Company  A  bought  the  stock 
of  B  at  200  per  cent.  Almost  immediately  after  the  purchase  Company 
B  paid  a  cash  dividend  of  25  per  cent.  In  what  ways  would  the  pay- 
ment of  this  dividend  affect: 

a.  The  balance  sheet  of  B. 

b.  The  balance  sheet  of  A. 

c.  The  consolidated  balance  sheet  of  A  and  its  subsidiary  companies. 
Give  your  reasons  for  your  answer.     (A.  1.  A.) 

254.  In  examining  the  accounts  of  a  department  store  corporation,  you 
find  that  it  is  the  owner  of  the  capital  stock  of  another  department 
store  corporation;  the  stock  is  carried  on  the  books  of  the  parent  cor- 
poration at  par.  Quarterly  dividends  have  been  regularly  received. 
What  further  information  would  you  require  before  certifying  the 
balance  sheet  and  income  account  of  the  parent  corporation? 

255.  A  holding  company  owns  the  stock  of  a  subsidiary  company,  for  the 
purchase  of  which  it  issued  two  shares  of  its  own  stock  for  each  share 
of  the  subsidiary  company's  stock.  The  assets  of  the  subsidiary 
company  were  sold  and  after  the  debts  of  such  subsidiary  company 
were  Uquidated,  the  balance  remaining  was  paid  in  cash  to  the  holding 
company.  How  should  the  cash  so  received  be  treated  on  the  books 
of  the  holding  company? 

256.  A  company  owns  all  of  the  capital  stock  of  another  company.  The 
latter  company  has  outstanding  an  issue  of  bonds  not  guaranteed  by 
the  company  holding  the  stock.  The  assets  of  this  subsidiary  company 
are  deemed  insuflBcient  to  cover  the  bonds,  so  that  its  capital  stock 
has  no  value.  The  owning  company  desires  the  auditor  to  prepare 
its  balance  sheet,  setting  up  the  assets  of  this  subsidiary  company  along 
with  other  assets  directly  owned,  and  the  bonds  as  liabilities.  Is  it 
proper  for  him  to  do  so  imder  the  circumstances?  Give  reasons  for 
your  answer. 

257.  In  a  combination  of  companies  into  one,  how  should  an  underlying 
company  charge  out  its  product  to  another  imderlying  company 
which  will  use  it  as  raw  material? 

258.  In  auditing  the  accounts  of  the  Brown  Manufacturing  Company,  you 
find  that  it  owned  the  controlling  interest  in  the  Smith  Foundry 


QUESTIONS  AND  PROBLEMS 


625 


Company.  In  addition  to  making  cash  advances  the  Brown  Company 
shipped  goods  to  the  Smith  Company.  At  the  end  of  the  year, 
namely,  December  31, 1920,  you  find  that  the  Smith  Company  appeared 
as  a  debtor  for  $50,000.00.  On  January  2, 1920,  the  Brown  Company 
had  received  from  and  credited  the  Smith  Company  with  notes 
receivable  of  $20,000.00.  These  the  Brown  Company  discounted  and 
on  the  due  date,  namely,  July  2,  1920,  took  them  up,  thereafter 
receiving  new  notes  from  the  Smith  Company.  These  were  due  on 
September  2,  and  the  procedure  of  July  2  was  followed.  These 
notes  taken  in  exchange  were  payable  on  February  2,  1921,  and  were 
discounted  by  the  Brown  Company  immediately  upon  receipt,  namely, 
on  September  2.  How  should  the  Brown  Company  balance  sheet  of 
December  31,  1920,  show  the  position  at  that  date?  Give  the  reason 
for  your  answer.  If  there  is  any  as  set,  how  much  is  it,  ^nd  under  what 
heading  should  it  be  included  in  the  balance  sheet;  that  is,  under 
current,  working,  or  what? 

259.  When  would  be  the  proper  time  for  a  holding  company  to  declare 
dividends? 

260.  Immediately  after  organization,  a  corporation  takes  over  certain 
highly  speculative  properties,  issuing  therefor  its  entire  capital  stock. 
Subsequently,  three-fourths  of  the  stock  issue  was  returned  to  treasury 
for  the  purpose  of  providing  wq^king  capital. 

Mu3h  of  this  was  underwritten  at  a  very  low  figure  and  none  was 
sold  at  par. 

At  the  end  of  the  first  year,  the  books  showed  fair  profits  from  opera- 
tion, but  dividends  in  excess  of  earnings  had  been  distributed  to 
stockholders. 

Early  in  the  second  year,  the  properties  had  been  developed  sufficiently 
to  indicate  wonderful  probabilities  and  the  prospect  was  used  com- 
mercially to  such  an  extent  that  market  trading  was  active  at  figures 
greatly  in  excess  of  par.  At  this  time,  the  corporation  trades  its 
balance  of  treasury  stock  holdings  for  control  in  a  holding  company 
whose  balance  sheet  indicated  a  book  value  of  less  than  par. 
What  was  the  price  paid  for  control  in  the  holding  company? 


PROBLEMS  ON  CHAPTER  XHI 
61 

Four  corporations.  Si,  S2,  S3,  and  S4,  are  controlled  by  corporation 
H.  These  four  companies  operate  separately,  buying  and  selling  both  to 
outside  parties  and  to  each  other.  Over  a  certain  period  of  time,  the 
operations  are  as  follows: 

SI  purchapes  raw  material  fron^  the  outside  in  the  amount  of  $100,000.00. 
It  sells  $20,000.00  of  this,  at  cost,  to  outside  parties,  and  $66,000.00  to  S2, 
at  a  cost  of  $60,000.00.  S2  expends  $34,000.00  in  manufacturing  labor 
and  expense  on  the  purchases  from  SI,  after  which  it  sells  $20,000.00  of  its 
goods,  at  cost,  to  outside  parties,  and  $70,000.00  to  S4,  for  which  S4  paid 


626 


ADVANCED  ACCOUNTING 


S2  $77,000.00  S4  received  these  eoods  over  the  raikoad  of  S3  and  paid 
the  latter  $5,000.00  in  freight  charges  upon  which  there  was  a  profit  of 
$1,500.00.  S4  expends  $18,000.00  in  manufacturing  labor  and  expense 
after  which  it  sells  $70,000.00  of  its  goods  at  cost,  to  outside  parties.  H 
For  the  purpose  of  the  consoUdated  balance  sheet  and  profit  and  loss 
statement  of  H,  determine: 

a.  First  cost  of  product  sold. 

b.  Intercompany  profit  on  sales. 

c.  Stock  on  hand.     (*) 

62 

The  following  are  trial  balances  aa  of  Deceml>er  31,  1920: 

H  Company: 
Real  estate, 

Machinery  and  equipment, 
Accounts  receivable, 
Cash, 

Inventories,  December  31,  1920, 
Shares— S  Company  (300,  par  $100.00), 
S  Company  current  account, 


$200,000  00 
100,000.00 
50,000.00 
10,000.00 
75,000.00 
35,000.00 
5,000.00 


Notes  payable. 
Accounts  payable, 
Capital, 
Surplus: 

Balance, 

Profit  for  year  1920, 

Totals, 

S  Company: 

Furniture  and  fixtures, 

Inventories,  December  31,  1920, 

Accounts  receivable. 

Cash, 

Treasury  stock  (100  shares  at  cost), 

H  Company  drafts  accepted  and  discounted, 

Accounts  payable, 

H  Company  current  account. 

Capital  stock  (500  shares,  par  $100.00), 

Surplus, 

$89,500  00      189,500.00 

The  stock  on  hand  of  S  Company  was  manufactured  by  H  Company  and 
was  billed  to  S  Company  at  10  per  cent  in  excess  of  cost,  at  which  value  it 
was  taken  into  the  inventory.  The  difference  in  the  inter-company  current 
accounts  consists  of  a  note  issued  by  S  Comjiany  in  settlement  of  a  claim 
for  damages  but  not  entered  on  the  books,  being  paid  by  H  Company.  The 
directors  of  S  Company  declared  a  dividend  of  VA  per  cent  on  December 
15, 1920,  payable  January  15,  1921,  which  has  not  been  entered  on  the  books 


$  20,000  00 

30,000.00 

400,000.00 

19,000  00 
6,000  00 

$475.00000  $475.000  00 

$  3.500.00 

25.000.00 

45.000.00 

5.000.00 

11.000  00 

$  5,000.00 

10,000  00 

4,500.00 

50,000  00 

20,000.00 


QUESTIONS  AND  PROBLEMS 

63 


627 


Company  A  purchased  on  January  1,  1921,  the  entire  capital  stock  of 
Company  B  at  $175.00  per  share,  and  the  entire  stock  of  Company  C  at 
$80,00  per  share. 

You  are  handed  the  balance  sheet  as  understated  at  June  30,  1921,  and 
are  requested  to  prepare  a  consolidated  balance  sheet  of  the  A  Company 
and  its  subsidiaries  at  that  date. 

Balance  Sheets 
Company  A: 

Property  and  good-will. 

Stock  of  subsidiary  companies. 

Current  assets. 

Capital  stock. 

Current  liabilities, 

Surplus  January  1, 

Undivided  profit  for  one-half  year, 

Company  B: 

Property  and  good-will. 

Current  assets. 

Capital  stock. 

Current  liabilities. 

Surplus  January  1, 

Undivided  profit  for  one-half  year. 


Company  C: 

Property  (as  appraised  January  1, 1921),  $1 .  130 , 000 . 00 

Current  assets,  180 ,  000 .  00 

Capital  stock. 

Current  habilities. 

Surplus  January  1, 

Undivided  profit  for  one-half  year. 


$    850,000.00 

1,500,000.00 

700,000.00 

$2,250,000.00 
150,000.00 
525,000.00 

125,000.00 

$3,050,000.00     $3,050.000.00 

$    650,000.00 
60,000.00 

$    400,000.00 

10,000.00 

200,000.00 

100.00000 

$    710,000.00    $     710,000.00 


$1,000,000.00 

240,000  00 

30,000.00 

40.000.00 


$1.310,000.00     $1,310.000.00 
There  are  no  inter-company  accounts  or  inventories. 

64 

From  the  following  three  trial  balances  prepare  a  consolidated  balance 
sheet  as  at  December  31,  1921,  in  the  form  you  would  draw  it  up  for  presen- 
tation to  the  stockholders  of  the  parent  company  (the  S.  R.  Company) 
showing  as  separate  items  therein: 

a.  The  total  good-will  of  the  coipbined  companies. 

b.  The  net  profits  accruing  to  the  new  corporation  (to  the  S.  R.  Co.). 
S.  R.  Company: 

Preferred  stock,  $1,500,000  00 

Common  stock,  1 ,  500 ,  000 .  00 


I 

,1 


I 


628 


ADVANCED  ACCOUNTING 


Investments  in  subsidiary  companies — 
4,000  shares  of  stock  of  L.  W.  Co.  and 
4,000  shares  of  stock  of  S.  B.  Co.,  both 
of  $100.00  each  at  cost, 

Accounts  payable. 

Dividends  from  subsidiary  companies. 

Administration  expenses, 

L.  W.  current  account, 

S.  B.  Company  advances, 

Cash, 

Organization  expenses, 

L.  W.  Company: 

Properties  and  plant. 

Good-will, 

Investment  in   S.  B.  Co.— 2,000  shares 

of  a  par  value  of  $100.00  each,   cost 

$300,000.00, 
Inventories, 
Receivables, 
Cash, 

Capital  stock  (4,000  shares), 
Accounts  Davable, 
S.  B.  Company, 
Surplus  (includes  $100,000.00  added  to 

book  value  of  investment  in  S.  B.  Co.), 
S.  R.  Company, 


QUESTIONS  AND  PROBLEMS 


$2,500,000.00 


25,000.00 

100,000.00 

150,000.00 

270,000.00 

75,000.00 


20,000.00 
100,000.00 


$3,120,000.00  $3.120.0()0.00 

$  325,000.00 
250,000.00 


400,000.00 

250,000.00 

195,000.00 

90,000.00 

$400,000.00 
125,000.00 
175,000.00 

710,000.00 
100,000.00 


S.  B.  Company: 
Good-will, 
Property  and  plant, 
Inventories, 
Receivables,  general, 
L.  W.  Company, 
Cash, 

Capital  stock  (6,000  shares). 
Accounts  payable, 
S.  R.  Company, 
Surplus  or  deficit, 

$    875,000.00    $    875,000~:0Q 

In  the  preparation  of  your  consolidated  balance  sheet  be  guided  by  the 
following  assumed  tacts: 

1.  That  the  S.  R.  Co.  was  formed  on  March  28,  1921,  and  acquired  its 
stock  ownership  in  the  two  subsidiary  companies,  as  shown  in  its  trial 
balance  on  April  1,  1921. 

2.  That  at  January  1, 1921,  the  L.  W.  Company  had  a  surplus  of  $605,000  00 
^d  the  S.  B.  Company  a  deficit  of  $50,000.00. 


$1,510,00000    $1,510,000:00 

$  60,000.00 
325,000.00 
190,000.00 
105,000.00 
195,000.00 
10,000.00 

$    600,000.00 

90,000.00 

150,000.00 

35,000.00 


629 

3.  That  no  inventory  wa^  taken  of  either  the  L.  W.  Company  or  the  S  B 

Company  between  January  1  and  December  31,  1921,  the  busbess  of 

the  companies  being  continued  without  interruption  notwithTnlJ 

4    That  n'"'  ?  T'"^^  ^'  *'^  ^"P^*^*  «*-^  -  -d-ated  above       ' 

d^v^denTof  $^00(^^^'^^  'VfV'''  ^-  ^^  ^^^^^^  ^^-^-^  * 

taktntpi^re'Zr.  7^  eitarb:r^^^^^^^ 

''  Jn^the^^  wTr  "  '""^  ""'"'  "^"'"'^'^  ^*^^^  *b«  S.  B.  Company 

trans  tand!^^^^^^^^^      "^'T''  ^  ^  *^^'^«^'  merchandiL  in 
transit  and  a^  to  the  remaining  $10,000.00,  a  charge  for  rental  of  w«r«- 

house  for  the  last  six  months  of  1921,  whi^h  ha«  been  c^^td  ^^^^ 
rent  account  on  the  books  of  the  S.  B.  Company.  *^  '^"^ 

fin  1  .'1^  ?  estimated  on  reliable  authority  which  may  be  accepted    a^ 
W  that  from  January  1,  to  March  31,  1921,  the  net^pS  o^  th" 

L  S   R  T""^  """T'^'^  *^  $30,000.00,  while  during  the  same  Ir^ 
the  b.  B.  Company  lost  $15,000.00.  ^ 

De!:l!r;L:T9^'r  '"^^  '^^^^^^  ^^  ^^^^^^^^  ^  -^  ^*«  -^-^-es  at 
Debits  Co.  A 


Cash, 
Accounts  receivable, 
Notes  receivable, 
Inventory,   raw    material 
1/1/20, 

Purchases,  raw  material. 
Labor, 

Manufacturing  expenses. 

Selling  expenses. 

Administrative  expenses. 

Inventory,  goods  in  process 
1/1/20, 

Inventory,  finished  goods. 
1/1/20, 

Plant  and  equipment, 

Investment  in  stock  of  Com- 
pany B, 

Investment  in  stock  of  Com- 
pany C, 

Credits 
Capital  stock. 
Notes  payable. 
Accounts  payable, 


$ 


75,000.00  $ 
350,000.00 
200,000.00 

150,000.00 
650,000.00 
450,000.00 
190,000.00 
85,000.00 
45,000.00 


Co.  B 

50,000.00  $ 
190,000.00 
60,000.00 

105,000.00 
400,000.00 
320,000.00 
190,000.00 
40,000.00 
25,000.00 


Co.  C 

60,000.00 

420,000.00 

40,000.00 

160,000.00 
510,000.00 
370,000.00 
205,000.00 
75,000.00 
35,000.00 


80,000.00    70,000.00    75,000.00 


90,000.00 
900,000.00 

875,000.00 
1,200,000  00 


65,000.00 
400,000.00 


80,000.00 
750,000.00 


$5,340,000  00  $1,915,000^  $"277807000:00 

$3,000,000.00$  500,000.00$  800,000.00 
110,000.00  80,000.00  60,000  00 
100,000.00    65,000.00   250,000  00 


630 


k. 


I;!** 


ADVANCED  ACCOUNTING 


Bonds  payable, 
Premium  on  bonds, 
Reserve  for  depreciation, 
Sales, 
Surplus, 


The  inventories  at  December  31,  1920  were: 


500,000.00 
5,000.00 
100,000.00  60,000.00        112,500  00 

1,400,000.00     1,050,000.00     1,250,000  00 
_    125,000.00        160,000.00        307,500  00 
$5,340,000.00  11.915,00000  $2,780,000.00 


Co.  A 


Co.  B 


Co.  C 


$175,000.00 

80,000.00 

145,000.00 


$210,000.00 

85,000.00 

105,000.00 


Raw  material,  $280 ,  000 .  00 

Goods  in  process,  95 ,  000 .  00 

Fmished  goods,  135 ,  000 .  00 

Company  A  purchased  the  entire  stock  issues  of  Companies  B  and  C 
at  January  1,  1920,  at  the  prices  shown  in  the  trial  balance.  During  the 
year  each  of  the  three  companies  declared  and  paid  a  5  per  cent  dividend. 
Company  A  took  up  its  dividends  from  Compames  B  and  C  by  credits  to 
surphis.  The  various  entries  for  the  dividends  were  the  only  entries 
atfectmg  the  surplus  accounts  during  the  year. 

At  December  31,  1919,  Company  A's  inventory  of  raw  material  included 
goods  purchased  from  Company  B  at  a  price  of  $60,000.00,  the  cost  thereof 
to  Company  B  being  $40,000.00. 

At  the  same  date  Company  B's  inventory  of  raw  material  included  goods 

n  •on'?^  J  f^^  ''''^^  Company  C  $160,000.00.  Company  B  still 
owes  $30,000.00  on  these  purchases,  the  indebtedness  being  included  in  the 
accounts  payable. 

«-?m  (^  m^^^^^  ^'^T-^  ^  '^^^  ^^^  *^  ^^^P^^y  A  at  a  cost  of 
$300,000.00  and  at  a  selhng  price  of  $375,000.00     Company  A  made  cash 

advances  totaling  $400,000.00  to  Company  B  during  the  year.     These  sales 

just  mentioned  were  charged  against  the  advances  account,  the  $25,000  00 

balance  of  which  is  included  in  Company  B's  accounts  payable. 

The  mventories  at  December  31,  1920,  include  inter-company  profits  as 


Company  A, 
Company  B, 


Raw 
Material 

$20,000.00 

30,000.00 


Goods  in 
Process 

$6,000.00 

6,000.00 


Finished 
Goods 

$4,000.00 

5,000.00 


Company  A's  bonds  were  issued  July  1,  1920.  They  bear  5  per  cent 
interest,  payable  semi-annuaUy  and  mature  in  five  years.  No  interest  has 
Deen  paid. 

AUow  depreciation  at  5  per  cent  per  annum  on  the  cost  of  the  fixed  assets. 

Prepare  the  following  consolidated  statements: 
Cost  of  goods  manufactured  and  sold. 
Profit  and  loss  statement. 


QUESTIONS  AND  PROBLEMS 


631 


Surplus  statement  (showing  as  the  final  balance  therein  the  surplus  balance 

appearmg  m  the  consolidated  balance  sheet). 
Balance  sheet.     (A.  I.  A.) 


li- 


QUESTIONS   ON   CHAPTER    XIV 

Twenty  Questions,  Five  Problems 

261.  What  are  fiduciary  accounts?     Give  three  examples 

262.  It  has  been  stated  by  a  writer  on  accounting  that  single  (or  simple) 
entry  is  the  basis  of  aU  fiduciary  accounting.  Do  you  agree?  State 
your  reasons. 

l^A'  wf  f /'''*  differentiate  executor,  administrator,  trustee. 

cuterl?        ^''^°*'^^  elements  are  involved  in  the  accounting  of  exe- 

265.  On  what  are  the  accounts  of  an  executor  based? 

266.  Describe  the  method  of  keeping  the  accounts  of  an  executor  and  state 
what  books  are  necessary  for  the  purpose 

267.  Define: 

a.  Intermediate  account. 

b.  Final  accounting. 

c.  Corpus.     (A.  I.  A.) 

d.  Income.     (A.  I.  A.) 

268.  In  what  books  should  an  administrator  keep  his  accounts?  What  if 
any,  special  ruhng  would  you  suggest?     Illustrate. 

269.  You  are  retained  to  open  books  for  the  executor  of  A.  B   deceased 

wo^Trd  '  'r'^  ''^'  T  "^"^'  P'^^"-  ^^^  *^^  accounts  thatl^u 
would  ordinarily  open.     State  from  what  documents  you  would  get 

o^n    i^^,^«^^<^>^^  o^  which  to  found  book  entries.  ^ 

piLt^h^  tok'^^^^^^  ^^^^^  ^^  ^^^^"^'  -^^'  ^-'  -  -  «--^  -H 

a.  Funeral  expenses. 

b.  Executor's  expenses. 

c.  Profit  or  loss  on  sale  of  investments. 

d.  Cash  dividend  on  investment  of  executor. 

e.  Cash  dividend  on  investment  of  testator. 

f.  Cash  legacies. 

g.  Property  legacies. 

h.  Quarteriy  allowance  to  widow 

"''  Srpu'^'*nfT*""'  '""'  ,^<»'»''>'«t'»to"'  account*  be  stated  for 

usuaUy  include?    What  are  assets  of  the  estate?    When  are  divi- 
dends   mterest  and  rente  U>  be  treated   a«   principal?     Wi^hwh^t 

272  ^*'':,«^«'="*«^  charge  himself  ?    For  what  does  he  take  ^Adit? 
272.  Define  the  nature  of  the  items  you  would  except  to  find  in  the  profit 

273  ^?f/7,^'""'"''t  "^k^Pt  by  the  executor  and  t^stee  of  a  large  esUte 
l^tb.T  eomPos'tion  of  the  "account"  of  an  executor  Jr^ 

274  Wl         Z?'"'"  **■« '""""te  relation  of  its  components 

274.  John  Brown  d.ed,  leaving  an  estate  consisting  of  realty'^nd^^onalty 


632 


ADVANCED  ACCOUNTING 


m 


hi 


and  in  his  will  named  George  Green  as  executor  and  trustee.  Under 
the  will  the  executor  was  vested  only  with  the  naked  power  of  sale 
(so  far  as  the  realty  was  concerned),  the  whole  estate  being  devised  in 
trust  for  the  benefit  of  a  sole  legatee.  George  Green,  as  exe(;utor,  sold 
a  certain  parcel  of  realty  to  William  Smith,  for  $3,000.00,  the  full  amount 
in  cash.  He  subsequently,  as  trustee,  advanced  Smith  $2,000,00  a«  a 
builder's  loan,  receiving  as  security  a  first  mortgage  on  the  property, 
including  the  improvements.  As  a  protection  he  further  received 
from  Smith  a  policy  of  insurance  for  $2,500.00  to  protect  the  mortgage. 
Two  years  later  Smith  defaulted  in  the  payment  of  his  interest  and 
taxes  and  would  pay  no  attention  to  the  tnistee's  requests  that  he  make 
such  payment.  Smith's  continued  neglect  resulted  in  foreclosure 
proceedings,  brought  by  the  trustee,  which  terminated  in  the  trustee's 
obtaining  title  to  the  property.  The  back  interest,  taxes,  and  fore- 
closure expenses  amounted  to  $375.00.  In  a  spirit  of  revenge  Smith 
set  fire  to  the  house  and  caused  its  total  destruction.  The  trustee 
obtained  $2,500.00  from  the  insurance  company  in  settlement  of  the  loss, 
and  subsequently  sold  the  lot  for  $2,000.00.  State  briefly  the  necessary 
entries  to  be  made  by  the  executor  and  trustee  to  record  properly  the 
amounts  so  received. 

275.  The  will  of  William  Christy  provided  for  a  division  of  his  estate  into 
three  equal  parts,  of  which  one  part  was  to  be  paid  in  cash  to  John 
Christy,  and  one  part  to  James  Christy,  and  one  part  was  to  be  held 
in  trust  for  the  benefit  of  Thomas  Christy,  who  was  to  receive  the 
income  therefrom.  January  1, 1921,  the  executors  had  $100,000.00  cash 
in  bank,  representing  the  amount  realized  from  the  bulk  of  the  testator's 
estate.  The  executors  paid  to  John  and  James  Christy  $30,(K)0.00  each 
and  lent  '$30,000.00  on  a  real  estate  mortgage  at  6  per  cent  interest. 
Prepare  necessary  ledger  accounts  for  the  books  of  the  executors. 

276.  A  person  dies,  leaving  a  will  disposing  of  a  personal  estate  that  is 
valued  by  the  appraisers  at  $36,470.00.  All  but  $209.00  is  disposed  of  by 
the  executor,  who  realizes  $32,131.00.  This  together  with  $2,187.00  of 
income  received  during  the  administration  of  the  estate,  constitutes 
the  full  sum  to  be  accounted  for.  The  testamentary  and  funeral 
expenses  amount  to  $512.00.  Debts  of  the  estate  to  the  amount  of 
$1,500.00  are  presented  and  satisfied.  Expenses  of  $700.00,  including 
trustee's  commissions,  are  paid  and  the  sum  of  $30,000.00  is  divided 
among  the  heirs.  Prepare  in  customary  form  a  summary  of  the 
executor's  accounting,  and  a  cash  account. 

277.  A  dies,  leaving  a  small  estate.  In  his  will  he  directed  the  creating  of  a 
separate  trust  for  each  of  his  two  married  daughters  and  also  provided 
that  the  residuary  estate  should  be  divided  between  the  two  daughters, 
share  and  share  alike,  on  the  death  of  the  widow  who  was  made  a  life 
tenant  of  the  residuary  estate.  When  called  on  by  the  executor  to 
prepare  his  accounts  for  filing  you  find  that,  as  the  income  from  the 
residuary  estate  was  not  suflBcient  to  pay  administration  expenses 
and  to  maintain  the  widow  as  she  had  been  accustomed  to  live,  the 
executor  had  made  a  loan  to  the  widow  from  the  principal  of  the  estate 


1^ 


QUESTIONS  AND  PROBLEMS 


633 


and  had  taken  as  security  non-income  producing  collateral,  the  loan 
being  made  without  interest.  Was  the  executor  authorized  to  make 
such  a  loan,  and,  if  so,  how  should  it  be  stated  in  the  executor's  ac- 
counting? 

278.  In  the  administration  of  an  estate,  the  executor  is  required  to  construct 
an  iron  fire  escape  on  the  front  of  the  building  in  order  to  remove  a 
violation  filed  by  the  fire  department  of  the  city.  Should  such  expense 
be  charged  to  principal  or  to  income  account?     Give  reasons. 

279.  As  an  executor  of  an  estate  you  receive  ten  shares  of  stock  as  a  dividend 
on  100  shares  of  the  same  stock  held  by  the  estate,  said  ten  shares  being 
a  distribution  of  earnings,  one-half  of  which  accrued  prior  to  the  death 
of  the  testator  and  one-half  since  his  death.  Does  such  stock  belong 
to  the  hfe  tenant  or  to  the  remainderman?     Explain. 

280.  If  called  upon  to  prepare  a  trustee's  accounting,  state  how  you  would 
handle  the  following  items:  The  trustee  sold  two  East  and  West 
Railroad  Company  first  mortgage  4  per  cent  bonds  which  he  had  received 
from  the  testator  as  a  part  of  the  estate  and  which  were  included 
m  the  inventory  at  $2,000.00.  These  bonds  were  sold  for  $1,800.00, 
and  $1,600.00  of  the  proceeds  were  reinvested  in  North  and  South 
Radroad  Company  three-year  6  per  cent  notes,  maturing  in  two  years 
from  the  date  of  purchase.  These  notes  were  redeemed  by  the  North 
and  South  Railroad  Company  at  par,  $2,000.00.  How  would  you  treat 
the  gam  of  $400.00,  resulting  from  the  purchase  of  the  short  term  notes? 


PROBLEMS   ON   CHAPTER    XIV 

66 

A  dies  on  June  1,  1918,  at  which  time  his  estate  consisted  of  the  following: 

Inventory  Realized 


Caah, 


$  43,500.00 

75,000.00    $  79,000.00 


1st  mtge  Mo.  Pac.  6  per  cent  bonds,  interest 

payable  April  1  and  October  1, 
Mortgage  loans-^  per  cent,  interest  payable 

March  1  and  September  1.     All  interest  due 

hasi  been  paid, 

Loans  to  sundry  persons. 

Preferred  stock— Acme  Mfg.  Co.,  at  par, 

Notes  receivable— interest  at  5  per  cent,  paid 

to  May  1,  1918, 
Investment  in  the  firm  of  K  &  L, 
Household  goods, 

$27  Mo!oo"^^'^'*'^'  '°  *^^  ^'^''''''^  ""^  S24,000.00,  actually  were  found  to  be 
The  following  legacies  were  mentioned  in  the  will- 

3.  Chas.  Moe,  3,000.00 

2,000.00 


40,000.00 

39,000.00 

125,000.00 

30,000.00 
34,000.00 
1,200.00 


36,000.00 

24,000.00 

128,000.00 

29,000.00 
36,000.00 


634 


ADVANCED  ACCOUNTING 


f  J^T'f!  ^""^"^^^  '"''«  11,100.00;  surrogate  court  costs  were  »2,400  00- 
fees  of  attorney  and  accountant  were  $1,000  00  •-•,»w.uu, 

Au^st'SloTr  '"'''  °"  ''"'^'*  '"'  '"''-  ''"''  *''^  '^«'''''*«  ''^^  P^<i  »° 
The  income  from  investments  was  received  as  and  when  due      The 
mcome  collected  to  October  31,  1918,  was  paid  the  widow  on  that  dat 

„  -^"J  ]'"'  °f'^  ^'^  """"^^^  P*"<^'  beginning  November  1    1018    th^ 

ilnlicated  .^th  *'^"'"''  '^'  *^  '=''***  "^'^  --  ---<^d  l''cLh 
as  indicated  in  the  column  above  headed  "realized  " 

Prepare  the  following: 

1.  Entries  necessary  to  open  executor's  books. 

2.  Entries  to  book  transactions  up  to  October  31,  1918 
o.  Matements: 

a.  Summary  of  cash  transactions  to  October  31,  1918 

b.  Charge  and  discharge  statement  as  of  October  31,  1918 

4.  Entries  to  book  transactions  subsequent  to  October  31,  1918 

5.  Ledger  accounts  for  the  above. 

6.  Trial  balance  of  above  ledger.     (*) 

67 

thr!^  n?V'''"K^!i^''''^  ^*^"""''  ^"""«^^'  «P^^»fi<^  bequests  were  made  to 
three  of  his  children,  viz.:  William,  $100,000.00  Marv  «75m^  m  a 
Emma,  $75,000.00.  A  sum  of  SH^Ci  ()n(\  nn^  \  ^',  ''^^'^^•^^  and 
instituiions    and  his  ddes^son    HenT*  w  ^""  'T'^**^'^  *^  '^""^'^^^^ 

was  as  foUows:  bonds  and  stocks  «t7^m   K    ,.  T^'  '■''^""*<""' 

.        ^'  l^f^B^,  etc-,  J118.7S;  improvements  on  real  estate    iTim  wi! 
repairs  on  real  estate,  $4,860.75;  taxes  and  insurance   $17^m.  i 

cemetery  lot,  $350.00;  services  of  accountant  TZm.?",   '  ""*  "^ 
bond    «1  Ann  nn      v>       •  j.  ai.cuuuiant,  $i,»oo.OO;  cost  of  executor's 

m327i)^„  H       T"*"   ^^"^   "^  '"""^^^    »'''  of  bonds   and  ,3L 
*2  28f7v'-  .       /""^  mortgages  paid,  $98,915.00;  sale  of  fur^ture    ete 
$2,285.75;  interest  on  bonds  and  morteaees   XAl  97n  vx.  .  7^   '^"'*'  **f' 

posits  with  trust  companies,  $l,275.rrenT$lf2im-^'-  TT  "^  '^'^ 
and  stocks,  $37,918  50  $17,250.00;  dividends  on  bond* 

t.e  foregoing  tran^ctions,  iLLdinSlorofTht  s^^X t^  ^^ 

Prepare,  with  the  distinction  as  to  Drinomfll  ar.A  • 
statement  of  the  executor's  accou" ,  ^how  ngthi  amoZ"^^.''  '"""^'^ 
commission  and  the  amount  due  the  residuafy  legaZ  '  ''"""""^  " 


n  •■' 


QUESTIONS  AND  PROBLEMS 


635 


»nH  f  ^K         ^1^  *""  '""^""^  °""  •**"«•'*«''  Doris,  and  two  sons,  Henry 
and  Arthur  all  of  age.     Her  will  directs  that  after  the  discharge  of  aS 

.tTu"A''  ?**'"  *•'*"'  '^^  ^  P'"^"*  ^  trust  for  FrederS^a  wLt^r 
tr  t^ Mnf  '^'^''^r*^^'  '50.00000,  the  income  of  which  is  t^  betS 
for  the  child's  support  by  the  guardian  appointed  under  the  trust  ^d^ 
pnncpal  to  be  paid  over  to  her  when  she  becomes  of  age.    Tr^mlder 

$7,400.00.  appraised  at  $2,000.00,  and  jewelry  appraised  at 

inWtlo^oni"'^''  T";^'  »50,000.00  at  5. per  cent,  is  in  arrears  of 
T^^L  XJ  '  f "1  f<"«''°«'^  proceedings  are  commenced  by  the 
executor,  with  the  result  that  on  an  immediate  settlement  the  estate  re^lize^ 

to  the  guardian  of  Fredericka  Winter.     The  February  and  August  semT 

ofTo^'S^"^?  V'  TT  r  '  "^^  "*''*  ■"  *"«  *-  -maining Tort^^ 
of  $100,00X00  each  and  the  January  and  July  interest  on  the  registered 

$9^^^  ^TW  '"  '^'^'^f ----•'  -d  the  bonds  are  forthwith  ^dS 
e!^  toHen  J^LT  u  ^"^^  »30.000.00  to  Doris,  and  $10,000.00 

^t  as^3  "ft  r  respectively,  on  account  of  their  interests.  Doris 
a^d  all  f  he  her  legacy,  household  furniture  $5,000.00,  clothing  $900.00, 

pLt^  his  iC^  the  appraised  valuation.  Each  of  the  sons  takes  a^ 
^  L      'f«^y  °°«  "f  the  remaining  bonds  and  mortgages. 

clo^ne  $rL  fjf*  Z'T't'^  *'^"'*^  ""*  ^"^^"^  ^'^  $15,000.00,  the 
Svei  fronir  in '  T  ^°T  ""'*  """^^  *^'^'^-     ^here  is  aUo  re- 

^nnl?^         ?"'  company  for  interest  on  deposit,  $350.00.    The  executor 

lees  wa«  fixed  by  the  will  at  $2,500.00. 

s.n?'.?^'^  *  summary  accounting  showing  the  cash  in  hands  of  executor 

atv^drrrd.'^'^'^^  ^  "^'  °^  ^'^  '^^  ^^  ^^^  ^^^-  ^'  ^^«  ^^-^"L^ 

i  69 

1.  Wm.  Doe  his  brother  was  made  executor. 

2.  A  legacy  of  SIO^.OO,  and  his  personal  jewelry  to  go  to  his  son,  George 

3.  A  legacy  of  $5,000.00,  and  his  electric  automobUe  to  go  to  his  dau^^i 

4.  That  his  widow,  Mary  M.  Doe,  should  receive  a  legacv  of  $5  000  00 
and  a  sum  additional  thereto  sufficient  to  pay  all  hous;hold  e^nS 
due  and  accrued  at  the  time  of  his  death.  expenses 


636 


ADVANCED  ACCOUNTING 


5.  That  his  widow,  Mary  M.,  shall  be  paid  an  allowance  of  $7,200.00  per 
annum,  and  to  have  full  possession  and  u«e  of  the  homestead  property 
from  the  date  of  his  death  to  the  final  distribution  of  the  estate. 
The  annual  allowance  herein  provided  to  be  paid  in  quarterly  payments, 
the  first  payment  to  be  made  three  months  from  the  date  of  his  death. 

6.  That  the  executor  should  use  his  best  judgment  in  the  disp«3sition  of 
such  assets  as  might  be  necessary  to  liquidate  the  liabihties  of  the 
estate,  to  make  immediate  payment  of  the  initial  legacies  to  his  widow, 
son  and  daughter,  and  to  make  the  quarterly  payments  to  his  widow 
as  provided  in  paragraph  5. 

7.  That  the  executor  shall  have  authority  to  sell  property  of  the  estate 
and  to  take  in  payment  therefor  either  cash  or  securities  but  that  the 
executor  is  not  of  authority  to  invest  the  proceeds  of  proi)erty  sales. 

8.  That  during  the  term  of  executorship,  the  executor  shall  receive 
$4,800.00  per  year  in  payment  for  all  services  (in  Heu  of  all  fees  and 
commissions)  but  such  salary  not  to  include  necessary  expenses  of 
the  executor. 

9.  That  the  final  distribution  of  the  estate  should  be  made  aa  soon  as 
possible  and  should  be  as  follows: 

14  to  the  widow,  Mary  M. 

}4  to  the  son,  George. 

}4  to  the  daughter,  Kate. 
On  March  15,   1921,  WiUiam  Doe  filed  evidence  of  executorship.     On 
April  1,  1921,  the  executor  filed  with  the  court  the  following  inventory  of 
the  estate  of  John  Doe. 


Inventory  April  1,  1921 

Filed  by  Wm.  Doe,  Executor 
Property 


Homestead  grounds  and  buildings, 

Renting  real  estate. 

Unimproved  real  estate. 

Rents  due  for  March, 

Cash  received  for  February  rent, 

Stock  of  the  C.  O.  D.  Rv.  Co., 

Certificates  of  deposit  dated  December  31,  1920,  at  4  per 
cent  interest,  figured  quarterly, 

Cash  in  bank,  checking  account. 

Personal  jewelry, 

Electric  automobile, 

Note  receivable,  dated  December  1,  1920,  for  one  year,  in- 
terest rate  6  per  cent,  payable  semi-annually, 

4  per  cent  bonds  of  the  Chicago  Street  Ry.  Co.,  par  $1,000.00, 
interest  payable  January  and  July, 

Note  receivable,  drawer  Wm.  Doe,  due  July  1, 1921,  without 
interest. 
Total, 


Appraised  Value 


$  40,000.00 

100,000.00 

80,000.00 

500  00 

500,00 

10,000.00 

6,000.00 

2,000  00 

300.00 

1,000.00 

4,000.00 

30,000.00 

1,000.00 
$275,300  00 


QUESTIONS  AND  PROBLEMS 


637 


Debts 

Mortgage  held  by  Trust  Co.  on  renting  real  estate,  due  Sep- 
tember 1,  1921,  interest  rate  6  per  cent  payable  annually, 

Note  held  by  Commercial  Bank— dated  February  1,  1921,  for 
four  months  at  6  per  cent. 

Accrued  household  expenses  for  February, 

Accrued  household  expenses  for  March, 

Unpaid  funeral  expenses. 

Sundry  personal  debts  of  John  Doe, 
Total, 


$20,000.00 

1,000.00 
150.00 
150.00 
700.00 
500.00 
$22,500.00 


During  the  period  of  executorship,  in  addition  to  the  specific  transactions 
required  by  the  provisions  of  the  will  and  the  ordinary  transactions  which 
do  not  reqmre  special  mention,  the  following  transactions  took  place: 

1.  The  revenue  producing  real  estate  was  sold  on  September  1    1921 
for  the  sum  of  $110,000.00  cash.     The  purchaser  assumed  all  unpaid 
taxes.     The  monthly  rents  ($500.00  per  month)  had  been  collected  to 
the  time  of  sale. 

2.  Notes  receivable  were  collected  when  due. 

3.  The  Chicago  Street  Ry.  Co.  bonds  were  sold  on  May  1    1921    for  102 
and  accrued  interest.  '  ' 

^*  1^,00^''^^  ^^  ^^^  executor  amounting  to  $850  were  paid  on  March 

5.  The  salary  of  the  executor  was  paid  on  March  31    1922 

6.  The  executor  paid  repair  and  unkeep  expenses  on  revenue  producing 
property  amounting  to  $900.00. 

7.  The  executor  paid  taxes  on  unimproved  real  estate  for  the  calendar 
year  1921    amounting  to  $3,600.00.     (Do  not  capitahze  in  solution). 

8.  The  executor  paid  taxes  on  the  homestead  property  for  the  calendar 
year  of  1921,  amounting  to  $1,800.00. 

9.  A  dividend  of  5  per  cent  was  received  on  the  stock  of  the  C.  O  D  Rv 
Co.  for  the  year  1921.  '    ^* 

MSr^2^^  '^'"^' '''"'  "°*  '^""^'^  ^^  ""^  '^'^  "''^  °°  '•'""* 

On  March  15  1922,  the  executor,  having  paid  aU  of  the  old  habilities 
of  the  estate,  filed  a  report  settng  forth  the  transactions  of  the  executor  and 
setting  forth  a  pUn  of  final  distribution  of  the  estate  in  accordance  wHh  the 
t^rms  of  the  wJl  The  plan  of  distribution  was  approved  by  aU  kgat^ 
and  the  court  on  March  31,  1922,  the  current  liaMities  were  liS^' 
the  divjsion  of  the  estate  wa«  accompUshed  and  the  executor  disch^d 

The  following  informaUon  is  to  be  submitted  either  in  the  form  of  separate 
schedu  es,  or  m  one  large  schedule  arranged  in  columnar  form 

1.  AssetsandUabilitiesof  theestateof  John  Doeatthe  time  of  his  decease 

2.  Cash  receipts  and  disbursements  from  the  decease  of  John  Doe  to 
the  close  of  the  executorship,  excluding  final  division  of  the  estate 

ofThe  111"      '"^'  "'  '^  ^"^  ^'"''="^''  *^'='"'^«  fi"'^  '^tribution 

4.  Liabihties  Uquidated  by  the  executor. 


638 


ADVANCED  ACCOUNTING 


5.  Expenses  of  the  estate  from  the  decease  of  John  Doe  to  the  close  of 
the  executorship. 

6.  Revenues  of  the  estate  from  the  decease  of  John  Doe  to  the  close  of 
the  executorship. 

7.  Legacies  to  the  widow,  Mary  M.,  excluding  final  distribution  of  the 
estate. 

8.  Legacies  to  the  son,  George,  excluding  final  distribution  of  the  estate. 

9.  Legacies  to  the  daughter,  Kate,  excluding  final  distribution  of  the 
estate. 

10.  Residual  assets  owned  by  the  estate  and  distributed  to  legatees  on 
March  31,  1922. 

11.  Use  your  total  figures  and  submit  proof  of  the  accuracy  of  your 
solution. 

A  division  of  the  residual  assets  according  to  the  terms  of  the  will  is  not 
required. 

70 

Upon  the  death  of  a  retired  business  man  in  June,  1920,  a  will  is  found 
conveying  real  and  personal  property  aggregating  $300,000.00  to  the  widow, 
who  is  his  second  wife,  for  her  life,  and  upon  her  death  to  four  children  in 
equal  shares.  It  is  discovered  after  his  death  that  his  first  wife  had  left  to 
her  two  children,  Henry  and  Enmia,  $20,000.00,  consisting  of  securities  for 
$10,000.00  bearing  6  per  cent  interest,  and  uninvested  cash  of  $10,000.00.  The 
father  had  regularly  collected  the  semi-annual  interest  on  the  investment,  but 
there  was  no  evidence  as  to  his  disposition  of  the  cash  portion  of  the  bequest. 
Exactly  ten  years  elapsed  between  the  death  of  his  first  wife  and  his  own 
death,  so  that  he  had  collected  twenty  items  of  interest,  the  last  one  just 
before  he  died.  Henry  and  Enmia  were  of  age  at  the  time  of  their  father's 
death,  and  had  never  been  informed  of  their  legacy. 

Prepare  a  statement  showing  what  would  accrue  to  each  of  the  four 
children  at  the  death  of  the  widow,  who  died  immediately  after  her  husband, 
including  the  amounts  to  which  Henry  and  Emma  would  be  entitled  on 
account  of  their  mother's  estate.  Exclude  and  do  not  consider  any  accrued 
income  of  the  estate  unexpended. 

Use  interest  rate  of  5  per  cent. 


QUESTIONS   ON   CHAPTER    XV 

Twenty  Questions,  Five  Problems 

281.  a.  What  is  a  receiver? 

b.  What  is  his  first  duty  on  taking  possession  of  profit  or  trust  funds 
committed  to  his  care? 

282.  a.  What  elements  enter  a  statement  by  a  receiver? 

b.  Prepare  an  exhibit  showing  the  construction  of  a  receiver's  state- 
ment. 

283.  Give  the  names  of  the  general  accounts  to  be  used  and  state  brieBy 
how  you  would  proceed  to  open  a  set  of  books  for  the  receiver  of  a 
smaU  manufacturing  concern,  the  court  having  issued  an  order  that 


QUESTIONS  AND  PROBLEMS  539 

the  receiver  shall  continue  manufacturing  in  order  to  utihze  to  the 
best  advantage  the  work  in  process  and  the  raw  material. 

284.  A  trading  company  votes  to  go  into  voluntary  hquidation,  the  direc- 
tors (three  m  number)  being  appointed  trustees,  to  reahze  on  the 
assets  and  pay  the  debts.  What  change,  if  any,  should  be  made  in 
the  bool^  of  the  corporation  and  how  should  the  trustees'  transactions 
be  recorded? 

285.  Outline  accounting  procedure  necessary  to  prepare  schedules  in 
bankruptcy  under  the  United  States  Bankruptey  Act.  State  schedules 
m  their  order  and  give  substantiaUy  what  each  contains 

286.  a.  If  appointed  an  assignee  for  a  corporation,  what  would  you  con- 
sider  to  be  your  first  duty? 

b.  How  should  the  assignee's  account  be  prepared  for  submission  to 
the  court? 

287.  a.  What  is  the  duty  of  the  assignee's  accountant  in  the  case  of  an 
assignment?  How  is  the  inventory  stated?  What  are  included 
in  the  schedules? 

b.  What  does  the  summary  of  account  usually  include?    With  what 

,«.    A  ^''^  T^l^  ''^^''^^  ^'^^^'^     ^^"  ^^^*  does  he  take  credit? 

288.  An   assignee   has   been   appointed   for   an   insolvent   manufacturing 
corporation  whose  habihties  and  assets  consist  of  its  capital  stock 
notes  and  accounts  payable,  unpaid  wages,  cash,  notes  and  account^ 
receivable?  raw  materials,  supplies,  finished  goods,  stock  in  process 
plant  and  balances  against  "branches."     The  assignee  is,  temporarily' 
to  handle  the  property  "as  a  going  concern."     You  are  placed  in 

relttf^e  to       ^''''''''''^'     ^^**  ^^  ^^^  ^*  ^^^  ^  ^  taken  by  you 

a.  The  Kabilities. 

b.  The  assets. 

c.  What  ledger  accounts  should  be  set  up  in  the  books  of  the  assignee? 
r^Recei^era^  ''^''^^  methods  of  stating  the  accounts  respectively  of: 

b.  Assignees. 

c.  Trustees  in  bankruptey. 

State  in  what  essential  respects  they  differ. 

290.  What  statements  are  drawn  up  to  present  the  affairs  of  an  insolvent 
busmess?     Give  a  form  of  such  a  statement  without  figures.  ^ 

291.  a.  Define  and  describe: 

1.  Statement  of  affairs. 

2.  Deficiency  account. 

b.  Show  wherein  the  following  differ: 

1.  Revenue  account. 

2.  Trading  account. 

3.  Profit  and  loss  account. 

4.  Deficiency  account. 

292.  a.  What  is  the  primary  object  of  a  statement  of  affairs?    (♦) 
b.  To  what  various  uses  may  such  a  statement  be  put?     (♦) 


289. 


640 


ADVANCED  ACCOUNTING 


QUESTIONS  AND  PROBLEMS 


641 


I  ' 


293.  Differentiate  fully  between  a  balance  sheet  and  a  staf(>ment  of 
affairs.     (*) 

294.  What  facts  should  be  made  clear  in  a  statement  of  affairs?  What 
conclusion  is  shown  in  the  final  balance? 

295.  a.  What  are  preferred  claims?    Cite  examples, 

b.  Are  there  any  circumstances  under  which  «ertain  liabilities  may 
take  precedence  over  a  first  mortgage? 

296.  a.  What  are  the  sources  of  information  upon  which  stattnnents  of 

affairs  are  based? 
b.  Define  the  following  terms  and  show  how  they  should  be  treated 
in  the  preparation  of  a  statement  of  affairs: 

1.  Unsecured  liabilities. 

2.  Partially  secured  liabilities. 

3.  Secured  liabilities. 

4.  Contingent  liabilities. 
6.  Preferential  liabilities. 

297.  Set  up  a  deficiency  account,  explaining  the  points  involved. 

298.  What  basis  would  you  suggest  for  valuing  the  assets  for  the  purpose  of 
constructing  a  statement  of  affairs? 

299.  In  preparing  a  statement  of  affairs,  against  what  account  or  accounts 
should  be  offset  the  contingent  liability  on  notes  receivable  dis- 
counted?. 

300.  You  are  instructed  by  the  receiver  of  an  importing  and  trading  concern 
to  examine  the  accounts  and  report  to  him  upon: 

a.  The  financial  position  of  the  concern. 

b.  The  causes  that  have  mainly  contributed  to  the  failure. 

In  your  answer  prepare  a  statement  of  the  assets  and  liabilitieB  in 
such  form  as  you  think  should  be  used  for  the  information  of  the  receiver 
and  the  creditors  and  under  (b)  state  the  matters  to  which  you  would 
direct  their  attention,  having  in  mind  the  nature  of  the  business  and 
how  you  would  proceed  with  your  investigation. 

PROBLEMS   ON   CHAPTER    XV 
71 


The  accounts  of  a  partnership  include: 
Cash, 

Merchandise, 
Accounts  receivable, 
Notes  receivable, 
Machinery, 
Real  estate, 
Investments, 

Mortgage  payable  on  real  estate. 
Notes  payable, 
Accounts  payable. 
Taxes  due. 


$  1,400  00 

15,000  00 

20,000  00 

4,000  00 

7,000  00 

6,000  00 

2,500  00 

3,000.00 

16,000.00 

35,000  00 

600.00 


Wages  due,  1,000.00 

Rent  due,  700.00 

Notes  receivable  discounted,  3 ,  000 .  00 

Partners'  accounts,  ♦                 12,000.00 

All  the  investments  are  pledged  as  collateral  on  $1,500.00  notes  payable. 
Of  the  accounts  receivable,  $1,000.00  are  considered  bad,  $2,500.00  doubtful 
and  worth  50  per  cent  of  book  value,  and  the  balance  good.  Real  estate  is 
undervalued  10  per  cent.  Merchandise  is  subject  to  a  discount  of  25  per  cent. 
Machinery  is  overvalued  25  per  cent.  $2,000,00  notes  receivable  discounted 
have  been  paid  by  makers.  Expense  of  liquidation  estimated  to  amount 
to  $1,500.00.     The  partners  have  personal  estates  valued  at  $4,000.00. 

Prepare  such  statements  as  seem  desirable  under  the  circumstances, 
and  state  probable  amount  for  distribution  among  creditors. 

72 

The  officers  of  the  A  company  find  that  they  are  unable  to  meet  current 
obligations  and  a  receiver  is  appointed  on  April  28,  1919.  The  receiver 
calls  for  an  inventory  and  a  statement  as  at  date  of  app)ointment,  which 
is  given  as  follows: 

Assets 


Machinery  and  equipment, 

Consigned  merchandise. 

Merchandise  at  mill. 

Cash, 

Accounts  receivable. 

Unexpired  insurance. 

Employees  Liberty  bonds, 


Liabilities 


Reserve  for  depreciation, 

J.  Smith  &  Co., 

Bank  loans. 

Acceptances, 

Bank  overdraft. 

City  taxes  accrued. 

Collateral  notes  payable, 

Mortgage  on  machinery. 

Accrued  interest  on  mortgage  (to  date), 

Lease — machinery. 

Accrued  interest  on  lease  agreement, 

Accounts  payable. 

Capital  stock  common. 

Capital  stock  preferred, 

Surplus, 


$507,300  00 

220,000  00 

115,000  00 

800.00 

,  1,400  00 

800  00 

4,700.00 

$850,000.00 


$     7,300.00 

260,000.00 

105,000.00 

15,000.00 

1,000  00 

4,000.00. 

4,700.00 

100,000.00 

3,000.00 

30,000.00 

10,000.00 

110,000.00 

100,000.00 

100,000.00 

10,000.00 

$860,000.00 


**.' 


?? 


642 


ADVANCED  ACCOUNTING 


QUESTIONS  AND  PROBLEMS 


643 


On  November  20,  the  receiver  having  disposed  of  all  assets  for  cash 
(except  consigned  merchandise  and  $400.00  accounts  receivable  which  were 
considered  doubtful)  calls  upon  you  to  prepare  an  interim  statement  for 
the  information  of  ♦the  stockholders  and  creditors. 

He  leaves  the  form  to  your  judgment  but  sugifcsts  that  it  be  as  concine 
as  possible  and  that  you  show  his  valuations,  as  well  as  book  value,  at  date 
of  receivership.  He  also  wants  a  summary  of  his  transactions  not  neces- 
sarily to  include  profit  or  loss  showing,  and  finally  wants  statements  to 
show  conditions  as  they  are  at  date  you  are  called  in. 

You  find  that  the  collateral  notes  payable  were  for  accommodation  of 
employees  and  were  secured  by  the  depvosit  of  bonds,  also  the  property  of 
employees  as  per  statement.  The  bonds  have  now  been  delivered  to  the 
employees  and  the  notes  paid  by  them. 

The  court  has  authorized  payments  of  the  city  taxes  and  accrued  interest 
of  $400.00,  which  latter  amount  has  been  omitted  from  the  statements 
but  included  by  receiver  in  his  valuation  statement.  Federal  taxes  were 
also  found  to  be  due  and  were  also  paid  (amount  $1,000.00) 

The  lease  covered  machinery  worth  $30,000.00,  but  the  firm  that  furnished 
this  machinery  has  accepted  a  release  of  the  A  company's  equity  in  this 
machinery  as  full  payment  of  notes  under  lease  agreement  and  the  accrued 
interest. 

The  receiver  finds  that  J.  Smith  &  Co.'s  account  represents  advances  on 
the  entire  consigned  merchandise  and  that  this  merchandise  has  been  pledged 
to  secure  this  claim  in  part  (to  the  extent  of  value  of  merchandise).  Receiver 
accepts  book  value  for  purpose  of  his  records. 

After  removal  of  the  leased  machinery  the  remaining  machines  and 
equipment  were  sold  for  $200,000.00,  and  the  mortgage  (and  accrued 
interest  to  date  of  payment,  $5,000.00)  were  paid  in  full.  (Receiver's 
original  value  placed  on  machinery  was  $200,000.00). 

The  merchandise  at  the  mill  was  valued  by  the  receiver  at  $75,000.00, 
but  after  six  months'  operation  the  amount  on  hand  was  sold  without 
inventory  for  $25,000.00. 

The  accounts  receivable  were  valued  by  the  receiver  at  $1,000.00  and 
the  amount  was  in  fact  realized  in  cash,  the  balance  appearing  doubtful 
(estimated  to  be  worth  50  cents  on  dollar). 

Unexpired  insurance  is  accepted  by  receiver  at  book  value.  November 
10,  a  rebate  of  $100.00  was  received  and  all  policies  were  cancelled. 

Upon  comparing  the  statement  with  the  books  you  find  accounts  payable 
understated  $10,000.00  in  the  statement  given  receivier  because  of  an  error 
on  the  part  of  a  bookkeeper  when  closing  the  books  at  April  28. 

Claims  were  duly  filed  for  entire  amount  owing  (except  $10,(XX).(X) 
accounts  payable).  An  account  in  purchase  ledger  was  disallowed  and  is 
in  dispute  (amount,  $5,000.00). 

The  receiver  sold  merchandise  to  the  amount  of  $75,000.00  all  of  which 
had  been  paid  for.  Other  receipts  were  rent  for  portion  of  building — 
sublet,  $1,000.00;  unclaimed  wages,  $500.00;  interest  on  bank  accoimt  to 
November  20,  1919,  $200.00;  cash  surrender  value  of  insurance  policy  on 
life  of  treasurer,  $1,000.00. 


Other  payments  were  receiver's  accounts  payable,  $50,000.00;  taxes, 
$3,000.00  (assessed  since  receivership);  rent,  $2,000.00;  legal  expense, 
$5,000.00.  No  fee  has  been  allowed  receiver  or  will  be  considered  in  your 
statement. 

An  analysis  of  the  ledger  determines  the  fact  that  only  the  following 
bills  and  expense  vouchers  had  been  carried  through  the  invoice  register  since 
receivership,  and  all  had  been  paid  promptly,  viz.:  labor,  $20,000.00; 
materials,  $20,000.00;  shop  expense,  $3,000.00;  heat  and  power,  $2,000.00; 
freight,  $1,000.00;  general  expense,  $4,000.00.     (A.  I.  A.) 

73 

Jones  &  Robinson,  merchants,  are  unable  to  meet  their  obligations. 
From  their  books  and  the  testimony  of  the  insolvent  debtors,  the  following 
statement  of  their  condition  is  ascertained: 

Cash  on  hand, 

Debtors:  $1,000.00  good;  $600.00  doubtful,  but  estimated  to 

produce  $200.00;  $1,000.00  bad, 
Property,  estimated  to  produce  $9,000.00, 
Notes  receivable,  good. 
Other  securities:   $3,000.00  pledged  with  partially  secured 

creditors;  remainder  held  by  the  fully  secured  creditors, 
Jones,  drawings, 
Robinson,  drawings, 
Sundry  losses, 
Trade  expenses, 
Creditors,  unsecured. 
Creditors,  partially  secured, 
Creditors,  fully  secured. 
Preferential  claims:  wages  and  taxes, 
Jones,  capital, 
Robinson,  capital. 


$  5,500.00 

2,600.00 

14,000.00 

4,250.00 


28,000.00 

9,000  00 

8,400.00 

13,500.00 

7,400.00 

25,000.00 

23,900.00 

17,000  00 

700.00 

10,000.00 

16,050.00 

Prepare  a  statement  of  afifairs,  showing  the  liabilities  and  the  assets  with 
respect  to  their  expected  realization  and  payment;  also  a  deficiency  account, 
showing  such  of  the  above  stated  particulars  as  would  account  for  the 
deficiency  shown  by  the  statement  of  affairs. 

74 

On  June  30,  Ward  &  Parker,  merchants,  announce  their  inability  to  meet 
their  obligations,  and  make  an  assignment  for  the  benefit  of  creditors. 

From  an  examination  of  their  books,  supplemented  by  other  information, 
their  condition  appears  as  follows: 

Liabilities 

Creditors,  unsecured,  $31 ,  250 .  00 

Creditors,  partly  secured,  29  875  00 

Creditors,  fully  secured,  21  250.00 

Taxes  and  Wages  of  Employes  (preferential),  875.00 


n^iMBik.^ 


644 


ADVANCED  ACCOUNTING 
Assets 


< 


Cash  on  Hand, 

Chattels, 

Bills  Receivable, 

Warehouse  Receipts  and  other  securities. 

Sundry  Debtors, 

Losses 
Profit  and  Loss  Account,  sundry  losses^ 
Trade  Expenses,  current  period. 

Personal 
Ward,  Capital  Account,  Cr., 
Ward,  Personal  Drawings,  Dr., 
Parker,  Capital  Account,  Cr., 
Parker,  Personal  Drawings,  Dr., 
Accounts  Receivable  show. 
Bad  Accounts, 
Doubtful  Accounts, 
Expected  to  Produce, 

The  securities  are  in  the  hands  of  creditors  pledged  to 
of  their  accounts,  viz.: 

In  hands  of  partly  secured  creditors. 
In  hands  of  fully  secured  creditors. 
The  chattels  are  expected  to  realize. 

Prepare  a  statement  of  affairs  and  a  deficiency  account. 

75 

The  RepuWican  Asphalt  Contracting  Company 
HDd  the  receiver,  when  taking  possession,  finds 
show: 

Liabih'ties: 
Bills  payable. 
Creditors  open  accounts, 
Mortgage  on  real  estate  and  improvements. 
Mortgage  on  contracting  equipment. 
Capital  stock  subscribed,  '         uqo 

Less  not  paid  up,  q  ' 


I  6,876.00 

17,500.00 

5,312.00 

35,000.00 

3,250.00 

•16,87.V00 
9,250.00 

•12,500  00 

11,250  00 

20,062  00 

10,500.00 

3,250  00 

1,250  00 

750  00 

250  00 

secure  payment 

I  3,750  00 
31,250  00 
11,250  00 


is  forced  into  liquidation, 
the  books  of  ac<^ount  to 


118,000.00 

75,500.00 

17,500.00 

7,000.00 


000  00 
500.00 


Assets: 

Cash  in  bank  and  office. 

Bills  receivable. 

Debtors'  accounts. 

Bonds  and  warrants. 

Real  estate  and  improvements, 

Manufacturing  plant. 

Contracting  equipment. 

Uncomplete  contracts  (cost). 

Inventory  of  materials  and  supplies, 


lOO  97,50000 

$216,000.00 

S   700.00 

4,300  00 
8,200.00 
23,000  00 
36,000.00 
24,000.00 
14,000.00 
41,000.00 

3.500.00 

$153,700.00 


QUESTIONS  AND  PROBLEMS 


645 

of  J2*'5'o^''m  wnr  '°  ??  ^K^''"^'^  '''''''^''  ""'^^"^  ^^^^  ^^  expenditure 
price  of  $60,000.00,  and  their  offer  of  $2,750.00  for  the  inventory  of  the  material 
and  supphes  as  paxt  of  said  expenditure,  is  accepted  by  the  receiver  tLI 
company  owes  for  personal  taxes  and  adjustment  of  employe^^  LbUitv 

rL3tZte/l^Oo'^'  T^'  "^^^^^^^^^'  ^^^  unpaid' laL^  accout^ 
ThT  h-n       *^'^^;^'  ^^«*^  ^^«"«^  do  not  show  on  the  books  of  account. 

$3,500.00  due  creditors,  and  $20,000.00  of  the  bonds  and  warrants  have  been 
given  as  security  for  $33,000.00  due  creditors;  $1,000.00  of  the  bills  receivable 
18  subsequently  dishonored.  receivable 

The  receiver  finds  that  $1,100.00  of  the  debtor's  accounts  is  collectible 

«4'^  nn  J^!^  ^""^  improvements  (book  value  $35,000.00)  realizes 

eoulZr/.r  r?^^\^^'  ^  ^'  '"^*  °^  ^^'  ^^  ^^1"«>  contracting 

equipment  35  per  cent  of  book  value. 

Prepare  a  statement  of  aflFairs  and  deficiency  account. 

QUESTIONS   ON   CHAPTER    XVI 

Ten  Questions,  Five  Problems 

301.  Distinguish  between  assignee,  receiver,  and  trustee,  and  state  their 
respective  duties. 

302.  Describe  the  following  and  show  wherein  they  differ: 

a.  Trial  balance. 

b.  Balance  sheet. 

c.  Statement  of  affairs. 

d.  Realization  and  h'quidation  account. 

303.  What  statement  is  drawn  up  at  the  end  of  a  receivership  to  show  the 

304   ^tll        "T'     ''T  "  '°"°  "'  «"<"'  »'**«"'-''  -*•>»"*  fiP^ 
3^^'  St  7^h  7°"*<'"<'° '«*''«  reaUzation  and  liquidation  account  used? 

305.  State  the  theory  and  the  practical  uses  of  a  realization  and  liquidation 

Xali^  *  **  *""  '""**'"*"  '"  "^"^  it  may  be  used  with 

306.  What  are  the  sources  of  information  upon'which  the  reaUzation  and 
liquidation  accounts  are  produced? 

307.  When  preparing  a  statement  of  reaUzation  and  liquidation  in  the  case 
of  a  company  dissolving  iteelf,  how  would  you  treat  reserves  Z 
depreciation?  State  three  methods  of  treating  the  matter  and  Jvl 
reasons  for  your  preference.  * 

308.  A  trading  corporation  votes  to  go  into  voluntary  Uquidation  the 
directors  (three  m  number)  being  appointed  trusts,  to  realL  on 

tioL'^be'^rtrl^^  ""'°''*''"'  '""'  ""^  ^"""^'^  '"^  '^^'  *— 

309.  OuUine  the  accounting  procedure  necessary  to  prepare  schedules  in 

, ,  „   n-  ?  ti  ?•*  ^^'  substantially  what  each  should  contafa. 

Sl'in^    ^r'°  *^'  ^t^t^mente  drawn  up  to  present  the  affairs 

J,  1      f^  f^  *"**  ^"^  '*"'"'°  "P  "*  *«  ^''d  of  >  receivershfa 

.    to  show  the  receiver's  operations.     (•)  »=™up 


0 


646  ADVANCED  ACCOUNTING 

PROBLEMS   ON  CHAPTER    XVI 

76 

Walter  Hopkins,  while  perfectly  solvent  and  doing  a  profitable  mami- 
factunng  business  bad  so  tied  up  his  capital  in  plant  and  materials  that  he 
was  unable  to  pay  his  debts  and  wm  on  the  point  of  suspending  for  want  of 
funds  to  pay  for  labor,  and  his  creditors  were  preparing  to  commence  legal 
proceedings  to  enforce  a  settlement.  The  condition  of  his  aflfairs  at  thi» 
time  was  as  follows: 

Balance  Sheet 

Assets 
Plant, 
Cash, 


$25,198.00    Creditors, 
212.00    Capital, 


Liabilities 


Materials,  raw  and  partly 

finished,  40,400.00 

Finished  goods,  6 ,  070 .  00 

Accounts  receivable,  3 ,  250 .  00 

$75,130.00 


Surplus, 


$20,230.00 
50,000.00 
4,900.00 


$75,130.00 


At  a  meetmg  of  creditors  he  said  that  whUe  his  plant  was  entirely  efficient, 
It  was  all  of  special  character  and  would  reaUze  on  forced  sale  only  the  value 
of  scrap,  that  the  unfinished  goods  would  require  the  employment  of  skill 
and  processes  known  to  him  only,  and  that  while  forced  suspension  would 
yield  to  his  creditors  not  over  50  per  cent,  it  would  ruin  him  absolutely 

The  creditors  decided  to  advance  him  a  loan  of  $5,000.00  to  continue  opera- 
tions  and  aUow  him  additional  credit  for  materials  and  expenses.  A  trustee 
was  appointed  to  see  that  the  proceeds  were  used  solely  for  the  recuperation 
of  the  business. 

The  subsequent  operations  under  the  supervision  of  the  trustee  were  as 
follows: 

•liT^^^^^  ^"^  ^'^''^  account,  charged  to  materials  $5,100.00,  to  expense, 
$12,100.00;  sales  on  book  account  $57,802.00;  losses  on  bad  debts  $300  00- 
cash  receipte  (loan  from  creditors)  $5,000.00;  settlement  from  debtors 
$58,100.00;  cash  payments  for  labor  $12,500.00;  for  expense  $4,350.00-  for 
plant  $600.00.  Creditors  $42,030.00;  Walter  Hopkins,  personal  drawings, 
$3,000.00. 

There  remained  raw  materials  $4,000.00,  finished  goods  $22,388.00. 
Prepare: 

a.  Realization  and  Liquidation  account. 

b.  Trustee's  cash  account. 

c.  Balance  sheet  of  the  estate  as  restored  to  Walter  Hopkins. 

77 

A,  B,  C  and  D,  partners  sharing  profits  equally,  decide  to  dissolve  part- 
nership and  on  December  31,  19—,  appoint  a  liquidator  and  transfer  all 
assets  to  him.  He  is  to  receive  for  his  services  5  per  cent  of  the  cash  collected 
by  him  in  the  liquidation  of  the  assets.  The  liquidator  is  also  to  be  allowed 
the  expenses  paid  by  him  in  the  liquidation  of  the  business  as  follows: 


QUESTIONS  AND  PROBLEMS  647 

Clerk  hire. 

Rent,  $1,000.00 

MisceUaneous  expenses,  Tm  ^ 

.nltw!!i'  "^'^^t-^^  i^'  ^  ^^^  P*^^  ^'^^  ^"  tte  notes  and  accounte  we^ 
collected  excepting  $3,200.00  of  worthless  and  uncoUectible  accouX  Thl 
furniture  and  fixtures  brought  12  800  no  onH  fK«  «.  u  ^..^^^^^'  ^ne 
$18  000  00  r.«.,h     tk!  k  1  *^'^'^'  ^'^^i  *be  merchandise  was  sold  for 

$18,000.C»cash.  The  balance  payable  to  partners  was  distributed  on  Decem- 
ber 31,  1^  No  interest  is  to  be  figured  on  the  partners'  accounts  or  on 
the  moneys  m  the  possession  of  the  liquidator.  Prepare  cash  Tcount  of 
hqmdater,  statement  showing  expenses  and  losses  in  hquidation  and  stltl 
ment  o^the  partneis'  accounts.  The  baknce  sheet  of  the  firm  on  I^ceml^ 
^1>  19 — ,  was  as  follows:  ^^cmuer 

Furniture  and  fixtures,    $3,500.00  Notes  payable. 

Merchandise  inventory,     20,500.00  Accounts  payable 

Notes  receivable,  14,000.00  Accrued  interest  on 

Accounts  receivable,  38,000.00        notes  payable. 

Unearned   insurance   pre-  Accrued  taxes 

nuum  expiring  in  19-,        800.00  A 's  account, 

^^^*  7,500.00  B's  account, 

"  C's  account, 
D's  account) 


$  5,000.00 
38,740.00 


$84,300.00 


80.00 

480.00 

16,000.00 

8,000.00 

10,000.00 

6,000.00 


$84,300.00 


78 


Harvey  Brothers    became  financially  embarrassed  and  a  trustee  w«« 
thTct^^trs^"^^  ''  '''''  "^  "^'^  ^'^^^  ^'  *^^^  ^^^-  ^-  ^^eaZ 

thel\rncttlfrfol^  '''  ^-^^^  — ^-  --  «^-  by 

Assets 
Cash  on  hand  and  in  bank, 

Bills  receivable,  ,jg  ^^ 

Accounts  receivable,  /^no 

Machinery  and  tools,  .  ^,ouu. UO 

Merchandise  inventory,  -» 

Real  estate. 


$  1,006.50 


22,500.00 
6,000.00 
4,350.25 

20,000.00 
$537856:75 


Bills  payable, 

Accounts  payable. 

Notes  receivable  discounted, 

Loan  payable. 

Mortgage  on  real  estate. 

Taxes  due. 

Mortgage  on  machinery  and  tools, 
Capital, 


Liabilities 


$6,000.00 

Q>000  00    $15,000.00 

10,000.00 

1,000.00 

15,000.00 

315.00 

5,000.00 

7j^641.75 

*53,856.75 


; 


648 


ADVANCED  ACCOUNTING 


In  order  advantageously  to  realize  on  all  asset^s,  the  trustee  purchases 
merchandise  to  the  amount  of  $10,000.00,  and  during  the  year  collected 
$21,350.00  cash  for  sales.  The  book  debte  reaHzed  $3,950.00.  Of  the  bills 
receivable  entered  in  the  balance  sheet  as  $18,000.00  there  was  on  hand  only 
$8,000.00,  the  balance  of  $10,000.00  having  been  discounted  with  the  bank 
and  which  are  represented  on  the  Hability  side  by  the  item  notes  receivable 
discounted.  The  $8,000.00  notes  on  hand  realizeti  the  full  sum,  while  of 
the  $10,000.00  discounted  with  the  bank  only  70  per  cent  could  be  realized 
the  balance  was  lost. 

The  bills  payable,  accounts  payable,  taxes,  and  interest  on  mortj^ages, 
(5}4  per  cent)  were  paid  in  course  of  settlement. 

Current  expenses  were  as  foUows:  Salaries,  $1,000.00;  office  expenses, 
$800.00;  legal  fees,  $1,200.00;  withdrawals  for  private  us3  by  the  owners, 
$2,000.00;  trustee's  commission,  $2,000.00.  On  January  1,  1921,  the 
trustee  surrendered  charge  of  the  estate  and  paid  over  the  cash  balance  on 
hand. 

There  remained  on  that  date  merchandise  on  hand,  $5,600.00. 
Prepare  a  realization  and  liquidation  account,  a  trustee's  cash  account, 
and  a  balance  sheet  of  the  estate  at  termination  of  trust. 

79 

James  Stetson  is  appointed  trustee  of  the  manufacturing  business  of 
John  Brightlawn,  for  the  purpose  of  rehabilitation.  On  taking  charge  he 
finds  that  the  available  assets  are:  Cash  in  bank,  $356.00;  accounts  receiv- 
able (a)  good,  $3,712.00;  probably  uncoUectible,  $350.00.  The  working  and 
trading  assets  consist  of:  Raw  materials,  $17,258.00;  sundry  manufacturing 
supphes,  $700.00;  finished  goods,  $8,000.00;  goods  in  process,  $30,945.70. 
Other  assets  comprise:  Machinery  and  machine  tools,  $41,000.00;  shop 
and  hand  tools,  $1,300.00;  deferred  debits  to  manufacturing,  $530.00.  The 
liabihties  are:  Creditors'  accounts,  $39,700.00;  wages  accrued,  productive, 
$500.00,  unskiUed  $230.00. 

The  transactions  under  the  trusteeship  are  as  follows:  Loaned  by  cred- 
itors for  immediate  needs,  $7,000.00.  Purchased  on  book  accounts:  raw 
materials,  $8,300.00;  sundry  manufacturing  suppUes,  $9,500.00.  Factory  ex- 
pense: Paid  in  cash  $1,300.00;  incurred  as  a  hability  to  creditors  and  sub- 
sequently hquidated,  $2,100.00.  The  doubtful  accounts  receivable  proved 
worthless.  Cash  paid  for:  Productive  labor  $16,000.00;  unskiUed  labor, 
$2,500.00;  general  expense,  $8,000.00;  additional  shop  tools,  $609.00;  freight 
mward,  on  raw  materials  manufactured  and  sold,  $60.00.  Interest  allowed  to 
creditors  on  their  accounts  amounted  to  $143.10.  The  trustee  advanced 
$4,300.00  to  John  Brightlawn  on  accountof  expected  profits;  the  sale  of  fin- 
ished wares  amoimted  to  $91,000.00. 

At  the  close  of  the  trusteeship,  the  trustee's  books  show  the  working  and 
trading  assets  to  be:  Finished  goods,  $11,000.00;  goods  in  process,  $10,450.00; 
raw  matenals,  $1,945.70;  manufacturing  supphes,  $395.25.  There  is  be^ 
sides  an  amount  of  $750.10  representing  factory  expenses  unapphed.  The 
creditors'  accounts  show  a  balance  of  $1,650.30.   wliile  the  uncollected 


QUESTIONS  AND  PROBLEMS 


649 


accounts  receivable  amount  to  $2,975.36.    The  shop  and  hand  tools  amount 
to  $1,609.00. 

Prepare  an  account  which,  while  respecting  the  fiduciary  character  of 
the  relations  of  the  trustee  and  the  proprietor  of  the  business,  will  reflect 
logically  and  clearly  the  result  of  J.  Stetson's  administration. 

ao 

The  following  is  the  trial  balance  of  the  Raw  Deal  Company,  June  1   1911 
on  which  day  the  directors  of  the  company  resolve  that  the  secretary  of 
the  company  be  authorized  to  call  a  meeting  of  the  stockholders  to  vot^  on 
the  immediate  dissolution  of  the  company: 

^^"^'  ^  15,000.00      *Bond     secured    by 


Building    and    realty 
fixtures, 

Machinery    and    ma- 
chine tools, 

Shop  and  hand  tools 
(in  store). 

Furniture  and  person- 
alty fixtures. 

Raw     materials     and 
freight  thereon, 

Accounts  receivable, 

Cash    in     bank    and 
offices, 


40,000.00 

35,000.00 

5,000.00 

9,700.00 

10,350.00 
23,400.00 

11,320.00 


$149,770.00 


mortgage  6  per  cent,    $  26,000.00 

Interest  accrued  on 
bond  secured  by 
mortgage. 

Accounts  payable. 

Reserve  for  deprecia- 
tion of  building, 

Reserve  for  deprecia- 
tion of  machinery. 

Reserve  for  deprecia- 
tion of  furniture 
and  fixtures, 

Surplus, 

Capital  stock,  au- 
thorized, issued 
and  outstanding, 


312.00 
21,700  00 

5,300.00 

8,000.00 


5,100.00 
23,358.00 


60,000.00 
$149,770.00 


*  Buildings  and  realty  fixtures  pledged  thereunder. 

fJ^^^J^"^^tt"^'  '"''*^''^  """^  ^'^^  ^^  ^^y  1'  1911'  ^^d  the  dissolution 
took  place      The  company  sold  the  building  and  its  equipment  to  the 

l\nrk  I^ottr -^  ^  ''  ""^^  ^^'  '''''    ^-  ^^--^-  1'  1-1'  the 

Debits:   Building  and  realty  fixtures,  $7,363.00;   machinery,  $25,340  00- 

shop  and  hand  tools,  $2,100.00;  furniture  and  fixtures,  $3,700.00-  accounts 

receivable,  $23,130.00;  raw  materials,  $7,950.00  '       accounts 

Credits:   Accounts  payable,  $21,700.00;    expenses,  $1,530.20. 

Prepare: 

a.  The  journal  entries  aflFecting  the  dissolution  of  the  company 

b.  A  statement  of  realization  and  liquidation  that  will  show  the  percent 
received  by  the  stockholders  on  their  holdings. 


INDEX 


Abstracting  accounts,  18 

receivable,  33,  34 
Accommodation  notes,  45,  46 
Account,  deficiency,  511-17 

working  capital,  133 

arrangement  for  balance  sheet,  10 

numbers,  10,  11 

valuation,  19 
Accountancy  defined,  1 
Accounting,    bonds   as  investments. 
199-211 

branches  of,  292 

capital,  23 

consolidations,  432-62 
defined,  1 
fiduciary,  463-539 
holding  company,  434-6 
merger,  432-62 
parent  company,  433-4 
receivership,  519^21 
Accounts,  abstracting,  18 
adjustment,  12 
intercompany,  442 
payable,  46,  47 
receivable,  32-4 
Accrual  basis  of  accounting,  22 
Accrued  assets,  21 

liabihties,  21,  300,  314 
Acts  of  bankruptcy,  502-3 
Accumulation,  201-3,  206-11 
Active  assets,  20 
Additional  income,  327-8 
Additions,  38 
Adjustment  account,  12 
Administrator  defined,  465-6 
Administratrix  defined,  465-6 
Advantages  of  corporation,  97-9 

double-entry,  7 
Advertising  expenses,  54 

d51 


Amending   incorporation    certificate 
139 

Amortization,  201-3,  206-11 
Analysis  of  credit  statements,  340-68 
Analysis  of  investment  statements 
369-99 

Annuities   and   sinking  funds,  287- 
90 

Application  of  resources  statement 

391-98 
Appraisals  and  depreciation,  233-4 
Appraisers  of  an  estate,  46^70 
Appreciation,  216 
Approval  sales,  50,  51 

Arrangement  of  accounts  for  balance 

sheet,  10 
Arrangement  of  ledger  accounts,  9 
Articulation  statement,  18 
Asset  and  liability  method  of  profit 

determination,  7 
Assets,  accounts  receivable,  357-9 
accrued,  21,  361-2 
active,  20 
bonds,  380-1 
buildings,  40-1,  376-7 
capital,  20,  299,  363-4,  375 
cash,  301-2,  354-6 
circulating,  20 
consignments,  361 
contingent,  21,  316 
current,  20,  301-8,  381 
deferred  charges,  21,  313,  362 
delivery  equipment,  378-^ 
savings,  379-80 
fire  insurance,  375 
fixed,  20,  363-4,  375 
floating,  20 
fimds,  381-2 
furniture,  378 
good-will,  43,  312,  445-7 
inventories,  30&-8,  359-61 


652 


INDEX 


Assets,    investments,  178-211,    304- 
5,  308-9,  381,  440-2 

land,  39-40,  375-6 

liquid,  20 

machinery,  41-2,  377-8 

notes,   acceptances,    accounts    re- 
ceivable, 302^,  356-7 

passive,  20 

patents,  43,  312,  380 

patterns,  43,  379-80 

permanent,  20 

properties,  309-10 

quick,  20 

secret,  21 

sinking  fund,  267-90,  309 

stock,  380-1 

trademarks,  44-5,  380 

trading,  20 

types,  20,  21 

wasting,  21,  38,  39,  233 

working,  20,  29^300 

working  funds,  302 
Assets  and  liabilities,  statement  of, 

4,5 
Assignment    in  favor  of    creditors, 

500-1 
Audited  vouchers,  16 
Auditing  defined,  1 
Average  due  date,  35 


B 


Bad  accounts  receivable,  33,  34 
Balance  sheet  account  arrangement, 

10 
Balance  sheet  accounts,  8,  292-340 

captions,  298-300 

comparative,  366-8 

consoUdated,  431-62 

form,  296-8 

titles,  295-6 

unclassified,  17 
Bank  deposit  preparation,  26 
Bank  discoimt,  32 
Bank  statement  reconciliation,  27-8 
Bankruptcy,  496-8 

act,  501-2 

acts,  502-3 


Bankruptcy,  statements,  505-9 

trustees,  50.'i-5 
Basic  accounting  equation,  7 
Basis  of  consolidation,  413-17 
Beneficiary  defined,  466 
Betterment,  38 
Bill  of  exchange,  29 
Bills  versus  notes,  29 
Blocking  the  ledger,  17,  18 
Blotter,  cash,  26 

daily,  26 
Board  of  directors,  102 
Bond  register,  156 
Bonded  Uabilities,  22 
Bonding  insurance,  58 
Bonds,  classification,  182-3 

collateral  trust,  188 

conditional,  183^ 

coupon,  186-7 

defined,  181 

discount,  265-7 

entries,  260-87 

expense,  265-7 

interest,  263-5 

investments,  199-211 

listing  on  exchange,  259 

mortgage,  187-8 

nominal  and  effective  interest  rates, 
201-3 

premium,  265-7 

premium  and  discoimt,  201-3 

present  value,  203-6 

registered,  185-6 

signatures,  259 

single,  183 

simdry  kinds,  18^91 

treasury,  259-60 

trust  agreement,  257-8 

unissued,  25^-60 

values,  192-3 
Booking  depreciation,  230-1 
Bookkeeping  defined,  1 
Bookkeeping,     estate,    473-6,    479- 

82 
Books  of  account,  cash  book,  2,  3 

day  book,  2, 3 

ledger,  3 
Book  value,  107 


INDEX 


653 


Branch  remittances,  54 

sales,  51,  53 
Buildings,  40,  41,  37&-7 
Burglary  msurance,  59 
By-laws,  102 

C 

Call  loans,  192 

Capital,  accounting,  23,  105-6 

defined,  23 

economic,  23 

working,  23 
Capital  assets,  20,  299 

construction,  36, 37 

foreign  branch,  53,  54 

sale,  36, 37 

valuation,  35-7 
Capital  expenditure,  25 
Capitalization  changes,  384-5 

CapitaUzation  of  consolidation,  417- 
24 

Capital  liabilities,  21 
Capital  profit,  24 

receipts,  25 
Capital  stock,  105,  106,  315,  383-4 

classes,  107-14 

no  par  value,  173-5 

premium  and  discount,  128-30 

subscriptions,  115,  116 

values,  106,  107 
Capital  versus  revenue,  316-9 
Cash,  301-2,  354-6 

internal  system  of  check,  6 
Cash  account  on  general  ledger,  28 
Cash  basis  of  accounting,  22 
Cash  blotter,  26 
Cash  discounts,  55,  56 
Cash  journal,  29 
Cash  payments,  internal  check,  5-6, 

27-8 
Cash  receipts,  internal  check,  26-8 
Cash    receipts    and    disbursements, 

29 
Cash  sales,  49 

Cash  short  and  over  account,  28 
Cash  surrender  value,  58 
Causes  of  depreciation,  217-8 


Certificate  of  incorporation,  103, 104 

139 
Certificates  of  stock,  116-8 
Charge    and    discharge    statement, 

482-5 
Charter,  103,  104 
Check,  internal,  2,  5-6,  27-8 

voucher,  15 
Circulating  assets,  20 
Classes  of  accounts,  adjustment  ac- 
count, 12 
balance  sheet,  8 
collective,  8 
controlling,  8 
impersonal,  8 
major,  8 
mixed,  8 
nominal,  8 
personal,  8 
primary,  8 
profit  and  loss,  8 
real,  8 

subsidiary,  8 
summary,  8 
suspense,  9 
Classes  of  capital  stock,  107-14 
Classes  of  ledgers,  11 
Classes  of  Uabihties,  21,  22 
Classification  of  accounts  defined,  7 
Classification  of  bonds,  182-3 
Classification    of    corporations,    100 
101 

Closing  books,   working  papers  for 

332-6 
C.  O.  D.  sales,  51 
Codicil  defined,  465 
Co-insurance,  57,  58 
Collateral  trust  bonds,  188 
Collective  accoimts,  8 
Combination  by  purchase,  404 
Committee  on  stock  list,  157 
Commodity  investments,  179 
Common  stock,  107 
Comparative  balance  sheet,  366-8 
Conditional  bonds,  183-^ 
Consignments,  52,  361 
ConsoUdated  statements,  431-62 
ConsoHdations,  432-62 


654 


INDEX 


Construction     and     bond     interest, 

265 
Construction  of  fixed  assets,  36,  37 
Contents  of  bankruptcy  statements, 

505-9 
Contingent  assets,  21,  316 
Contingent  items,  22,  23,  316 
Contingent  land  gift,  39,  40 
Contingent  liabilities,  21,  53,  316 
Contingent   losses   as   depreciation, 

218 
Contracts,  balance  sheet  set  out,  76 

entries,  77-9 
Controlling  accounts,  8 
Controlling  cost  records,  87-91 
Copyri^ts,  44,  45 
Corporate  officers,  143 

records,  143-56 
Corporation  advantages,  97-9 
Corporation  amending  certificate,  139 
Corporation  by-laws,  102 
Corporation  cancellation  of  redeemed 

bonds  and  coupons,  291 
Corporation  capital,  105,  106 
Corporation  capital  stock,  105,  106 
Corporation  certificate  of  incorpora- 
tion, 103,  104 
Corporation-charter,  103,  104 
Corporation  combinations,  399-403 
Corporation  committee  on  stock  list, 

157 
Corporation  defined,  93,  94 
Corporation  directors,  102 
Corporation  directors'  powers,  140-2 
Corporation  disadvantages,  99,  100 
Corporation  dividends,  241-55 
Corporation  filing  incorporation  cer- 
tificate, 137-9 
Corporation  franchise,  103,  104 
Corporation  incorporation  procedure, 

102 
Corporation,    joint    stock    company 

distinguished  from,  96 
Corporation  merger  versus  consolida- 
tion, 399-431 
Corporation    no    par    value    capital 
stock,  173-5 
obhgations,  256-90 


INDEX 


Corporation  officers,  143 
Corporation   opening    entries,    119- 

28 
Corporation,      partnership      distin- 
guished from,  95,  96 
Corporation  records,  143-56 
Corporation  shares  of  stock,  102 
Corporation  stockholders,  102 
Corporation   stock  issued  for  prop* 

erty,    157-61 
Corporation  stock  ledger,  119 
Corporation  stock  premium  and  dis* 

count,  128-30 
Corporation  stock  values,  106,  107 
Corporation,   transfer  of  business  of 

partnership,  169-73 
Corporation,   transfer  of  business  of 

sole  trader,  161-5 
Corporation,    treasury    stock,    130- 

6 

Corporation,  vendor's  procedure  on 

sale  to  corporation,  16^-9 
Corporation  classification,  100,  101 
Cost  accounting,  betterment  orders, 
87 

control  methods,  87-91 

defined,  M 

maintenance  orders,  87 

order  method,  86,  87 

orders,  85-7 

process  method,  86 

production  orders,  86 

purposes,  85 
Cost  finding,  84 
Cost  of  goods  sold,  324-6 
Cost  of  manufactured  product  sold, 

339 
Coupon  bonds,  186-7 
Courts  of    competent  jurisdiction — 

estates,  467 
Credit  department  expense,  54 
Credit  statement,  340-68 
Cumulative  dividends,  255 
Cumulative  stock,  108 
Current  assets,  20,  301-«,  381 

foreign  branch,  54 
Current  financing,  351-2 
Current  liabilities,  21 


655 


Daily  blotter,  26 
Day  book,  defined,  2-3 
Decedents'  estates,  463-95 
Declaring    and    paying    dividends, 

247-53 
Deductions  from  income,  328-^ 
Deductions  from  sales,  323 
Deferred  charges,  21,  313,  362 
Deferred  credits,  314-5 
Deficiency  account,  511-17 
Deficit,  23,  300 

Deferred  charges  to  operation,   21 
313,  362 

Deferred  credits  to  income,  21,  314^-5 
Deferred  items,  22,  23,  313-5,  362 
Dehvery  equipment,  378-9 
Depletion,  38,  39 
Depreciation,  212-34 

buildings,  40,  41 

causes,  217-8 

land,  39,  40 

leaseholds,  40 

machinery,  41-2 

patents,  44 

patterns,  43 

tools,  42,  43 

Depreciation  as   operating  expense, 
218-9 

Determining    depreciation     charges 
221-30  ' 

Devisee  defined,  465 
Direct  labor,  82 
Directors,  102 
powers,  140-2 

Disadvantages  of  corporation,  99, 100 
Disbursements,  25 
Discount,  bank,  32 

bond,  265-7 

cash,  55-6 

stock,  128-30 

trade,  55 

true,  32 

Discount  and  interest  on  notes  re- 
ceivable, 32 

Discount  on  investments,  consoU- 
dated  statements,  441  5 


IHscounted  notes  receivable,  30,  31 
Dishonored  notes  receivable,  30 
Dividends,  242-55,  314 

and  surplus,  241-55 
Double-entry,  advantages,  7 

basic  records,  7 

changing  from  single-entry,  5 

defined,  1 

Doubtful  accounts  receivable  34 
Draft,  29 
Drawings,  379-80 
Due  date,  average,  35  - 
Duties  of  administrator,  467-8 
Duties  of  executor,  467-8 
Duties  of  receiver.  498,  519 


Earnings,  23,  24 
Economic  capital,  23 
Equipment,  dehvery,  378-9 
Equity  receivership,  498-9 
Estate,  appraisers,  469-70 
assets,  46^72 

bookkeeping,  473-76,  479-82 
corpus,  476,  493-95 
debts,  472-3 
decedents,  463-95 
defined,  465 
income,  466,  490-93 
insolvent,  496-539 
principal,  466,  493-5 
Executor  defined,  465 
Executor's  accounting  to  court,  477-9 
Executrix  defined,  465 
Expenditures,  25 
Expense,  advertising  54 
credit  department,  54 
financial,  24 
non-operation,  25 
purchasing  department,  54 
warehouse,  54 
Expenses,  25 
advertising,  54 
cost  of  goods  sold,  324r-6 
general,  327 
manufacturing.  325-6 
selling,  326-7 


656 


INDEX 


F 


Factors     determining     de{»^ciation 

amount,  219-21 
Factory  overhead,  83 
Fiduciary  statements,  463-539 
Filing    certificate    of    incorporation, 

137-9 
Financial  expense,  24 
Financial  income,  24 
Financial  statements,  19 
Fire  Insurance,  375 
Fire  loss,  57-8 
Fixed  assets,  20 

construction,  36,  37 

foreign  branch,  53,  54 

sale,  36,  37 
Fixed  and  capital  assets  valuation, 

35-7 
Fixed  charges,  25 
Fixed  liabilities,  21 
Floating  assets,  20 
Fluctuation,  215-6 
Foreign  branch  sales,  53,  64 
Forms  of  business,  92 
Formulas,  44 
Franchise,  45,  103-4 
Friendly  trustee,  518 
Fully  paid  stock,  114,  115 
Fund    £HW:)hcation    statement,    368, 

391-8 
Funded  debt,  314 
Funded  liabilities,  22 
Funds,  237-240,  302 

working,  302 
Future  delivery  sales,  51,  52 


G 


General  expenses,  327 
General  factors  of  investment  enter- 
prise, 370-4 
Goods,  internal  system  of  check,  6 

in  transit  account,  16 
Good-will,  43,  312,  445-7 

consoUdated  statements,  445-7 
Gross  profit,  24 


Gross  sales,  322-3 
Guaranteed  sales,  53 


Heir  defined,  465 
Hire  purchase  plan,  50 
Holding  companies,  431-63 


Illegal  dividends,  245-7 
Impersonal  accounts,  8 
Income,  23,  24 

financial,  24 

and  expenses,  29 
Incorporation   certificate,    103,   104, 
139 

amended,  139 

filed,  137-9 
Incorporation  procedure,  102 
Indirect  labor,  83 
Insolvency,  496-8 
Instalment  records,  147-9 
Instalment  for  sinking  fund,  287-90 

machinery  purchase,  41,  42 

sales,  50 
Insiunnoe,  56-9 
Insurance,  bonding,  58 

burglary,  59 

cash  surrender  value,  58 

liabUity,  58 

life,  58 

marine,  59 

register,  56 

short  rate,  57 
Inter-company  accounts,  442 
Inter-company  sales,  442-3,  447--8 
Interest  and  discount  on  notes  re- 
ceivable, 32 
Internal  check,  system  described,  2, 

5-6,  27-8 
Intestate  defined,  465 
Inventories,  305-8,  359-61 

approval  sales,  51 

goods  lost  in  transit,  53 
Investment  statement,  369-^ 


INDEX 


657 


Investments,  178-211,  304-5,  308-9, 

381,440-2 
Invoice,  29 
Items  in  transit  account,  16 


Jettison  of  vessel's  property,  59 
Joint    stock    company,    corporation 

distinguished  from,  96 
Joint  ventures,  74-5 
Journal,  cash,  29 

stock,  154 
Journalizing  defined,  11 
Journahzing  rules,  8 


K 


Kinds  and  classes  of  capital  stock. 
107-14 


Labor,  direct,  82 

indirect,  83 

productive,  82 
Land,  39-40,  375-6 
Large  versus  small  business,  369-70 
Leaseholds,  40 
Ledger,  arrangement  of  accounts,  9 

blocking  the  ledger,  17,  18 

factory,  87,  88 

stock,  150-3 

Ledger    arrangement,    accounts    re- 
ceivable, 33 

Ledgers,  accepted  as  evidence,  12 

classes,  11 

defined,  11 

self-balancing,  12 
Legal  organization,  60 
Legatee  defined,  465 
Letters  of  administration,  468 
Letters  testamentary  defined,  468 
Liability  insurance,  58 
LiabiUties,  300,  313-5,  364-6 

accounts  payable,  313,  365-6 


Liabilities,  accrued,  21,  314 
bonded,  22,  382 
capital,  21,  366 
contingent,  21,  316 
current,  21,  383 

deferred    credits    to    income,    21 

314-5 
dividends  payable,  314 
fixed,  21,  366 
funded,  22,  314 

notes    and    acceptances    payable. 
313,  365 
License,  45 
Life  insurance,  58 
Life  tenant,  488-90 
Liquid  assets,  20 

Liquidation  and  realization,  521-39 
Loan  investments,  193-5 
Loans  secured  by  collateral,  191-2 
Loss  in  transit,  53 
Loss  on  notes  receivable,  31 


Machinery,  41,  42,  S77-S 

ledger,  42 
Major  accounts,  8 

Manufacturing,  account  groups.  80 
81  ' 

expenses,  83 

seUing  price  components,  81 

control,  chap.  3 
Margin  of  safety,  385-7 
Marine  insurance,  59 
Market  value,  107 
Material,  83 

received  report,  48,  49 
Merger  versus  consolidation,  432-62 
Mergers  versus  consolidations,  399- 
431 

Methods  of  depreciation  determinar 
tion,  221-30 

Mining  company  dividends,  247 

Minority  interests,  consohdated  state- 
ment, 447 

Minute  book,  145 

Mixed  accounts,  8 


658  INDEX 

Mortgage  bonds,  187-8 
Mortgages  receivable,  184-5 


INDEX 


659 


N 


National  bankruptcy  act,  501-2 
Net  profit,  24 
Net  sales,  323-4 
Net  worth,  single  entry,  4,  5 
New  York  Stock  Exchange,  156 
Nominal  accounts,  8 
Nominal  and  real  accounts,  chap.  2 
Nominal  value,  106, 107 
Non-cumulative  stock,  108 
Non-operation  e3q)ense,  25 
Non-speculative  investments,  195-9 
No  par  value  capital  stock,  173-5 
Notes,     acceptances,     accoimts    re- 
ceivable, 302-4,  356-7 
Notes  and  acceptances  payable,  45, 

46,  313 
Notes,  acconmiodation,  45-6 
payable  register,  31 
receivable,  30 

discounted,  30,  31 

dishonored,  30 

interest  and  discount,  32 

loss,  31 

register,  31 
versus  bills,  29 
Numbering  accounts,  10,  11 


O 


OflBcers  of  corporation,  143 
Opening    entries,    corporation,    11^ 

28 
Operation  profit,  24 
Orders,  betterment,  87 

maintenance,  87 

production,  87,  88 
Organization,  legal,  60 

working,  60 
Original  entries,  11 
Overdrafts,  301 
Overhead,  83 

distribution  methods,  83,  84 


Parent    versus    holding    companiefl, 

431-62 
Passive  assets,  20 
Partly  paid  stock,  114,  115 
Partners,  classification,  62,  63 

rights,  duties,  powers,  64 
Partnershifis,  chap.  3 
Partnership  advantages,  61 

agreement  contents,  63,  64 
Partnerships,  classification,  62,  63 
Partnership,       corporation       distin- 
guished from,  95,  96 
Partnership  defined,  60 
disadvantages,  61  ,62 
dissolution,  71,  74 
interest  allowances,  64,  65 
interest  on  capital,  70 
investment  to  secure  interest,  66 
opening  entries,  65-7 
operation,  68 
profit  and  loss,  65 
profits,  68-9 
purchasing  interest,  66 

in  profits,  67 
salaries,  65,  68 
Par  value,  106,  107 
Passive  assets,  20 
Patents,  43,  312,  380 
Patterns,  43,  37^80 
Payment  of  dividends,  247-53 
Period  of  an  annuity,  290 
Permanent  assets,  20 
Permanent  investments,  195-9 
Personal  accounts,  8 
Petty  cash,  28 
Premiimi  bonds,  265-7 
Premium  stock,  128-30 

stock,  128-30 
Powers  of  directors,  140-2 
Preferred  stock,  108,  109,  110 
Premium    on    investments,    consoli« 

dated  statements,  444-5 
Preparation  of  bank  deposit,  26 
Primary  accounts,  8 
Prime  cost,  83 
Private  cash  book,  28 


I'M 


)l 


y/ 


Probating  a  will,  468 
Problems,  chapter  1,  pp.  542-5  (1- 
5) 

2,  548-52  (6-10) 

3,  554-7  (11-15) 

4,  560-2  (16-20) 

5,  565-8  (21-5) 

6,  569-71  (26-30) 

7,  577-81  (31-5) 

8,  584-7  (36-40) 

9,  590-8  (41-5) 

10,  601-5  (46-50) 

11,  610-3  (51-5) 

12,  617-22  (56-60) 

13,  625-31  (61-5) 

14,  633-8  (66-70) 

15,  640-5  (71-5) 

16,  646-9  (76-80) 
Productive  labor,  82 
Profit,  24 

capital,  24 
gross,  24 
net,  24 
operation,  24 

statement     of    determination^    4, 
5 
Profit  and  loss,   asset  and  hability 
method  of  determination,  4,  5 
accounts,  8 
credits,  329 
debits,  329 
statement,  292-340 
consolidated,  449-50 
item  arrangement,  321-9 
titles,  319-320 
Profit-sharing,  255 
Profits  and  dividends,  243-5 
Promissory  note,  29 
Properties,  309-10 
Proprietor  sales,  49 
Proprietorship  investments,  193-5 
Purchase  book,  47,  48 
Purchase  order,  48 
Purchase  requisition,  48 
Purchase  returns  and  allowances,  47, 

54 
Purchases,  47,  48,  49 
Purchasing  department  expense,  54 


Questions,  chap.  1,  pp.  540-2  (1-20) 

2,  545-8  (21-40) 

3,  552-4  (41-60) 

4,  557-9  (61-80) 

5,  562-5  (81-100) 

6,  568-9  (101-20) 

7,  572-7  (121^0) 

8,  581^  (141-60) 

9,  587-90  (161-80) 

10,  598-601  (181-200) 

11,  605-10  (201-20) 

12,  613-7  (221-40) 

13,  622-5  (241-60) 

14,  631-3  (261-80) 

15,  638-40  (281-300) 

16,  645  (301-10) 
Quick  assets,  20 


I 


Rates  of  depreciation,  229-30 

Real  accounts,  8 

Real  and  nominal  accounts,  chap.  2 

Real  estate  investments,  180-1 

Real  value,  107 

Realization  and  Uquidation,  521-^ 

Recapitulation  of  sales,  49 

Receipts,  25 

Receiver  defined,  519 

Receivership,  equity,  498-9 

accounting,  519-21 
Reconciling  bank  statement,  27-8 
Register  for  bonds,  156 
Register  for  insurance,  56 
Register  for  notes  payable,  31 
Register  for  notes  receivable,  31    • 
Registered  bonds,  185-6 
Remainderman,  488-90 
Renewal,  37,  38 
Reptdrs,  37 
Replacements,  38 

Replacing  depreciated  assets,  232-3 
Report  of  material  received,  48,  49 
Requisition  for  purchase,  48 
Reserve  for  appreciation,  37 
Baserve  for  bad  debts,  34 


660 


INDEX 


Reserve  for  cash  discounts,  55,  56 
Reserve  for  exchange  fluctuations,  53 
Reserves,  300,  315,  385 

and  reserve  funds,  234,  241 
Returns  and  allowances,  purchases,  47 
Revenue,  23,  24 

expenditure,  25 

receipts,  25 

versus  capital,  316-9 
Royalties,  44 
Rules  for  journalizing,  8 


S 


Sale  of  fixed  assets,  36,  37 
Sales,  49-54 

approval,  50,  51 

branch,  51 

cash,  49 

C.  O.  D.,  61 

consignments,  52 

deductions,  323 

Foreign  branch,  53,  54 

future  delivery,  51,  52 

gross,  322-3 

guaranteed,  53 

hire  purchase  plan,  50 

instalment,  50 

inter-company,  442-3,  447-8 

net,  323-4 

proprietor,  49 

returns  and  allowances,  54 

book,  49 

orders,  49 

recapitulation,  49 
Schedule  of  ledger  balances,  17 
Scrip  dividend,  254-5 
Secret  assets,  21 
Secret  reserves,  240-1 
Securities,  178-211 
Self-balancing  ledgers,  12 
Selling  depreciated  assets,  232-3 
Selling  expenses,  326-7 

future  delivery  sales,  52 
Shares  of  stock,  102 
Short  and  over  account  for  cash,  28 
Short  rate  insurance  basis,  57 
Sight  drafts  as  checks,  27 


Smgle  bonds,  183 
Single-entry,  advantage,  3 

changing  to  double-entry,  5 

defined,  chapter  1 

disadvantages,  3-4 

principles,  chap.  1 

statements,  4,  5 

where  used,  4 
Sinking  funds,  267-90,  309 
Specific  real  and  nominal  accounts, 

chap.  2 
Speculative  investments,  195-99 
Statement  of  affairs,  107 
Statement,  affairs,  511-7 

appUcation  of  resources,  391-8 

articulation,  18 

charge  and  discharge,  482-5 

of  affairs,  511-7 

of  assets  and  liabilities,  4,  5 

of  cash  receipts  and  disbursements, 
29 
Statements,  consoUdated,  431-62 

articulation,  18 

balance  sheet  and  profit  and  loss, 
292-340 

comparative  balance  shc^et,  366-8, 

391-2 
consolidated,  431-62 
cost  of  manufactm^d  product  sold, 

339 
credit,  340-368 
fiduciary,  463-539 
financial,  19 

fund  application,  368,  391-8 
income,  368 
investment,  369-99 
of  income  and  expenses,  29 
of  profit  and  loss,  31^29 
of  profit  determination,  4-6 
opinion,  20 

pubhcity  through,  374-5 
resources    and    their    ai)plication, 
391-8 
Stock,  380-1 
certificate  book,  149  ,150 
certificates,  11&-8 
dividend,  253-4 
exchange,  156 


■        »r 


1 


INDEX 


661 


Stock,  holders,  102 

issued  for  property,  157-61 

journal,  154 

ledger,  119,  150-3 

list  committee,  157 

premiums  and  discount,  128-30 

subscriptions,  115,  116 

transfer  book,  155,  156 

treasury,  130-6 
Subscription  records,  145-7 
Subsidiary  accoimts,  8 
Summary  accounts,  8 
Simdry  kinds  of  bonds,  188-91 
Surplus  and  dividends,  241-55 
Surplus,  315-6,  385 

reserves,  236-7 
Suspense  accounts,  9 
.  bad  debt  reserve,  9 


Temporary  investments,  195-9 

Testator  defined,  465 

Time  draft,  46 

Tune  loans,  191-2 

Tools,  42,  43 

Trade  discounts,  55 

Trademarks,  44-5,  380 

Trade  secrets,  44 

Trading  assets,  20,  299-300 

Trading  of  trustee,  518-39,  524-39 

Transfer  of  business  of  sole  trader  to 
corporations  161-5 

Transfer  of  partnership  to  corpora- 
tion, 169-73 

Transit  loss,  53 

Treasury  stock,  130-6 

Trial  balance,  2,  17 

True  discount,  32 

Trust  agreement,  257-8 

Trustee  defined,  466,  518 

Trustees,  487 
in  bankruptcy,  503-5 

Trustee's  trading,  518-39 

Trusts,  486-7 

Turnover,  56 

Type  of  assets,  20,  21 

Types  of  assets,  20-1 


Tjrpes  of  cash  books,  28-9 
Types  of  liabiUties,  21,  22 
Two  bases  of  accounting,  22 
Two  systems  of  bookkeeping,  1-2 


U 


Unaudited  vouchers  account,  16 
Unclassified  balance  sheet,  17 
Unexpired  insurance  premiums,  56-9 


1 


Valuation  of  balance  sheet  accounts, 

19 
Valuation  of  fixed  and  capital  assets, 

35-7 
Valuation  reserves,  235-6 
Vendor's  procedure  on  sale  to  cor- 
poration, 165-9 
Vessel  jettison,  59 
Voting  trust,  142 
Voucher  record,  47,  48 
Voucher  check,  15 

jackets,  13,  14 

numbers,  15 

record,  14,  15 
Voucher  system,  advantages,  15 

disadvantages,  15,  16 

description,  13 
Vouchers,  audited,  16 

defined,  12 

vouching  entries,  13 

payable  accoimt,  16 


W 


Warehouse  expense,  54 

Wasting  assets,  21,  38-9,  233 

Working  assets,  20,  299-300 

Will  defined,  465 

Will  probated,  468 

Working  and  trading  assets,  299-300 

Working  capital,  23,  133 

Working  funds,  302 

Working  organizations,  60 

Working  papers  closing  books,  332-6 


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